How Apple, Amazon, Alphabet, and Microsoft Became $1 Trillion Companies
On January 16th, the market cap of Google’s parent company Alphabet crossed over $1 trillion for the first time, and the company joined Apple, Amazon, and Microsoft as the only U.S. companies to ever achieve that once unimaginable valuation. The way these four businesses have grown — and continue to grow even at their massive size — is remarkable, and there’s a unique trait they all share that other companies can learn from.
To put in perspective just how impressive that feat is, the combined value of Microsoft, Apple, Amazon, and Alphabet at $4.97 trillion dollars is worth more than the entire London Stock Exchange. As in, all 3,000 companies on the LSE added together. If Alphabet, Apple, Amazon, and Microsoft (let’s call them “MA3,” to make things easier) broke off and formed their own stock exchange, it would collectively be the fourth largest stock exchange in the world, trailing only the NYSE, NASDAQ, and Tokyo Stock Exchange.
And it’s not just the sheer size of MA3 that’s jaw-dropping — the rate of growth has been staggering, too. In the past 10 years, MA3 has grown from $588 billion in combined market cap to nearly $5 trillion. That’s a 23.8% IRR (internal rate of return), which would be double the IRR of the S&P 500 (11.8%) and the Dow Jones Industrial Average (10.5%) during that time.
By at least one measure, MA3 is growing even faster than startups, which are known for astronomical expansion. One way to quantify startup growth is by looking at the performance of their investors. Cambridge Associates publishes a benchmark of the investing performance of venture capital and breaks out the return performance of the top quartile of VC firms who in theory are investing in the top startups. If you average returns from these best firms over the past decade, you get a 22.9% IRR, which is outstanding but still below that of MA3.
Microsoft is so big that to grow just 1%, it has to add the entire market cap of Pinterest.
In other words, simply buying and holding Microsoft, Apple, Amazon, and Alphabet stock would have outperformed even the top VC firms around.This shouldn’t be happening. Companies are either huge in value and growing slowly because of that size, or growing quickly off a small base. But MA3, the most valuable U.S. companies in the history of U.S. companies, are somehow growing their already enormous value faster than small startups who are thought of as the embodiment of growth.
Microsoft is so big that to grow just 1%, it has to add the entire market cap of Pinterest. Yet in 2012 alone, Microsoft has already increased in value more than 16%. That’s 16 Pinterests they’ve created since January 1st. How is that possible? How do we have four trillion-dollar companies growing at startup rates? How does MA3 continue to do what no other group of companies can do?
Because they aren’t like other companies.
The costs of doing business
In 1937, renowned economist Ronald Coase published his seminal article “The Nature of the Firm,” in which he explains why people come together to form partnerships, companies, and other corporate structures as opposed to just conducting business with other individuals through a free market. Traditional economic theory suggested that a free market should be more efficient than any other organizing structure. But Coase pointed out that there are external transaction costs when individuals do business together — things like establishing trust, exchanging information, aligning on goals and incentives, and so on that increase the expense of free market collaboration.
However, within a company, you can remove many of those transaction costs because everyone is working together in the same organization, governed by the same set of rules and procedures.
As an example, think about two individual contractors who want to work together on a project. Before they start, they would first have to assess the credibility of the other to decide if they should go into business. Then they would need to sign a confidentiality agreement so they could exchange information. From there, they would negotiate pricing and payment terms, all the while having to hire other contractors for support (for example, lawyers, escrow agents, and so on). These are all external transaction costs that must be paid before any real work can even begin.
Now think of that same situation but instead of two individual contractors, we have two coworkers who want to work together on a project. These two coworkers can begin collaborating immediately because there’s trust, credibility, processes for information exchange, and common incentive structures already in place simply by being a part of the same company. Sure there are still transaction costs within the company (like having to get approval from management to collaborate on the project), but these internal transaction costs paid by coworkers are less than the external transaction costs paid by contractors. The existence of a company has therefore lowered overall transaction costs and made collaborating with others much more efficient, which is why companies exist in the first place, according to Coase.
And it’s also why companies are successful. As long as their internal transaction costs are lower than external transaction costs for the same project, the company has an economic advantage versus the contractor, which in turn fuels the company’s success and growth.
But that advantage isn’t indefinite. As a company gets larger, so do the complexities of its operations. There are now multiple offices and divisions, multiple product lines and businesses. And with it comes more bureaucracy to navigate, more corporate politics that muddy goals and incentives, separate teams with their own processes, remote colleagues with no shared history to establish trust, and so on.
All of these side effects of success lead to one outcome: internal transaction costs increase. And as internal transaction costs increase, growth slows. Eventually the company will start to contract if internal transaction costs become more expensive than external transaction costs. In other words, a company can get to a point where it’s more efficient to do business outside the company than inside it, which is also the point where the company loses that very business. The economic advantage now resides with the contractor, not the company.
It’s an endless cycle of shifting economic advantages. Companies form and lower transaction costs versus the free market, which makes business more efficient inside the company. As the company grows, so do its internal transaction costs, which then makes business more efficient on the free market. A company’s past success inevitably creates headwinds for future success. But what if there was a way to break the cycle? What if companies could keep internal transaction costs lower than the free market even as they grow in size and complexity?
Learning from the trillion-dollar club
On September 16, 2015, Microsoft CEO Satya Nadella gave the keynote presentation at Salesforce’s annual Dreamforce conference, which was a bit surprising given the two companies’ rivalry in the CRM software space. Nadella pulled another surprise when during the keynote, he demoed Skype, Outlook, and other Microsoft products running on an iPhone, something that previous Microsoft CEOs would never have endorsed. But Nadella’s biggest surprise was not what he did, but what he would go on to say that day:
“Our customers are going to make choices that make the most sense for them, and they’re not going to be homogenous choices…and it’s incumbent on us, especially for those of us who are platform vendors to partner broadly…”
The CEO of Microsoft, a company once sued by the U.S. Department of Justice for anticompetitive practices against other platforms, telling the world he now wanted to embrace partnerships with platforms? A company whose previous CEO Steve Ballmer once referred to their top platform competitor Linux as a “cancer that attaches itself in an intellectual property sense to everything it touches”? Surely this was nothing more than polite rhetoric to get a nice applause from the audience. Nadella couldn’t possibly be committing Microsoft to anything actionable here, right? Turns out he was doing exactly that.
Causing your own short circuits
Ronald Coase’s theory of the firm is that businesses become successful because of their lower internal transaction costs, but that very success inevitably leads to more complexity and higher transaction costs that impede further growth. But Coase also offers a way to lower transaction costs:
“Inventions which tend to bring factors of production nearer together, changes which tend to reduce the cost of organizing spatially, changes which improve managerial technique will tend to increase the size of the firm.”
In other words, if companies can do things that force focus and efficiency, they can lower internal transaction costs. I call these intentional short circuits, or ISCs. Like an electrical short circuit, ISCs cut through the impedance that’s built up in a system. But unlike electrical short circuits, ISCs are planned shortcut paths designed specifically to streamline business decisions and remove complexity. And in Coase’s world, less complexity means less transaction costs, allowing a hugely successful company to continue growing even larger.
So what’s Microsoft’s ISC? Nadella told the world at Dreamforce with the words “partner broadly”: short circuit who Microsoft’s customers are by working with, not against, everyone. Think back to Ballmer calling Linux and open source software a “cancer.” Last year, Microsoft shipped a full Linux kernel inside of Windows 10 for the first time ever. Guess who is the world’s overall largest open source contributor? Microsoft.
In recent years, Microsoft has forged strategic partnerships with storage competitors Dropbox and Box, database competitor Oracle, Red Hat, SAP, Adobe, Apple and more. While companies like Walmart and Kroger won’t use any service from Amazon (including AWS), gaming giant Sony formed a cloud alliance with its number one console gaming rival Microsoft. Microsoft has gone from the feared competitor out to destroy companies, to the safe ally out to support industries. As Salesforce CEO Marc Benioff puts it: “Before, we just were not able to partner with Microsoft. Satya has opened a door that was closed. And locked. And barricaded.”
Microsoft employees can short-circuit how they think about the entire corporate landscape: Everyone is a friend, not a foe. When you work at Microsoft, there’s no one you can’t or won’t collaborate with so there’s no need to create complexity around what customers to pursue, what partnerships to strike, what alliances to form. With Microsoft’s short circuit, every employee’s definition of a customer just got a lot simpler. And simpler means fewer internal transaction costs.
Amazon CEO Jeff Bezos had a similarly enlightening quote at the Code Conference in 2016 when he said: “When we win a Golden Globe, it helps us sell more shoes.” That described Amazon’s ISC: a business model that works across all products.
The beauty of Amazon’s business model is just how transferable it is. From its early days of creating the world’s largest bookstore, Amazon has always built its business from one thing: customer purchases. And that’s all any internal group with any business ambition needs to remember. Want to expand from books into CDs and DVDs? Go ahead because those are customer purchases. Want to sell toilet paper, detergent, air fresheners, and plastic wrap? Yup, those too are customer purchases. How about offering sweaters, hats, skis, batteries, power tools, dog food, cat food, and bird food? Also customer purchases. And what if we want to give things away like unlimited digital photo storage, free e-books, and free premium streaming videos? Go right ahead because that will simply lead to customer purchases.
By focusing on consumer purchases, Amazon employees use a singular monetization strategy that can span from consumables to cosmetics, from groceries to gaming, from premium media to prescription medicine, and more. No matter what you’re doing at Amazon, you only need to know about one short-circuited business model that’s consistent across all products and services. Consistency that reduces internal transaction costs, and helps sell more shoes.
One of Apple CEO Tim Cook’s favorite pastimes during his keynote at WWDC (Apple’s marquee developer conference) is to poke fun at Android fragmentation, meaning there are so many different versions of the Android OS, with inconsistencies between them all, still running on devices all over the world. In Cook’s keynote at WWDC 2013, he said “if you do the math, you would find that iOS 6 [the current OS at that time] is the world’s most popular mobile operating system, and in second place is a version of Android which was released in 2010.” The very next year, Cook referred to Android fragmentation as “turning devices into a toxic hellstew of vulnerabilities.” And every year, Cook makes sure to present a slide comparing penetration numbers of the latest iOS release versus the latest Android OS release.
The digs are certainly amusing, but beneath them is something far more interesting. Cook is showing us what Apple’s ISC is: its platform.
People who work at Apple effectively think about one version of one platform. That’s it.
Managing multiple versions of products (including supporting old, legacy versions and cross platform versions) is a big challenge for companies. There are five different major versions of Android that have at least 10% market share with no single version having more than 30%. That includes Android 5.0, which was released in 2014 but is still running on 14% of Android devices. Windows 7, released nearly 11 years ago, is still running on 26% of computers. So Google and Microsoft not only have to maintain multiple versions of the same products, but some which are built on decade-old technology. That’s a lot of added complexity, and in Coase’s world, more complexity equals more internal transaction costs.
Contrast that with Apple, whose latest release of iOS (version 13) is already on 70% of devices despite having only launched this past September. Then factor in unlike Google and Microsoft, Apple doesn’t support other platforms — there’s no iMessage for Android or Keynote for Windows. The result? Apple employees don’t deal with legacy overhead, they don’t have cross-platform dependencies, there are no technology conflicts of interest.
People who work at Apple effectively think about one version of one platform. That’s it. In a world where working at other tech companies means fighting platform battles on so many different fronts, working at Apple becomes a lot simpler when your platform choice is short-circuited, creating lower internal transaction costs.
Google’s ISC has been discussed a lot over the past year. News outlets have reported on it. The U.S. government has held hearings about it. And last May, Google CEO Sundar Pichai penned a New York Times op-ed about it. What is it? Data. Lots and lots of data.
In many ways, Google’s data short circuit embodies the short circuits from the other trillion-dollar companies above. Like Apple’s singular focus on their own, latest platform, data is itself the key platform for Google. Like Amazon’s customer purchase business model that is transferable across all its businesses, data is transferrable across all parts of Google. Like Microsoft’s willingness to work with all partners, Google services work on all platforms covering all customer scenarios (emails, photos, documents, entertainment, communication, consumer, enterprise) to collect data.
Google may have nine different services and counting with more than 1 billion users each, but underlying them is one data strategy that makes all those services, and the tens of thousands of people building them, still fit together. If you’re on the Gmail team, the data you gather helps Google Maps coworkers improve address accuracy. Those Google Maps employees then help their Google Search coworkers with local entity discovery. And those Google Search employees help their YouTube coworkers with video recommendations. Everyone at Google is connected through the common pursuit of collecting and using data to make their businesses more personalized, more intelligent, and more useful. But data also helps make Google products and services more efficient for Google to build by lowering internal transaction costs.
No one wants to stop at $1 trillion
After hitting an all-time high on February 19th, Google stock dropped 13% over the next 10 days and ended February (along with Amazon) with a market cap of less than $1 trillion. So MA3 is now simply MA, or Microsoft and Apple. But of course, that missing comma in their valuation doesn’t take anything away from what all of these four remarkable companies have accomplished as they continue to rewrite the limits of internal transaction costs.
There’s no doubt that we’ll soon have MA3 back together again. The only question now is how soon before we start the $2 trillion dollar club.