Last month, Microsoft became the third U.S. company to hit a market capitalization of $1 trillion. The first was Apple, and the second was Amazon — they breached that threshold last summer. One key to growth for these tech behemoths? All three rely on software as a service as a key revenue generator. Take a look at this graphic from the Financial Times, showing market capitalization over time for Apple, Amazon, Microsoft, and Alphabet, which is getting close:

(Source: Peter Wells, Bloomberg, via Financial Times)

How have these companies grown to be so huge? All three have leveraged their subscription business model past the usual modes of recurring income for continued value. Specifically, all three have made it inconvenient for customers to use competing services. The word “inconvenient” does a lot of work in that sentence because these firms have made it so inconvenient that users feel they have no choice but to stick with the company. When a critical mass of subscribers will not switch from a company to any competitor, that huge customer base gives the subscription giant massive market dominance — in the absence of similarly sized competitors, that’s something like a monopoly.

Here, take a look at two graphs. First, the total market capitalization of all publicly traded U.S. firms:

(Source: World Bank, via Statista)

Now, look at the top five companies:

(Source: Forbes, via Statista)

For 2018 data, the total value was $30.44 trillion. For the top five — tech juggernauts all — the total was $3.76 trillion. Five companies — all in technology — are worth over 10% of the total!

Old-time monopoly laws were concerned about companies cornering markets and raising prices, to the clear detriment of consumers. Modern monopolies dominate markets by giving customers great value for low prices and then locking those customers in.

At Vox, Matt Yglesias explains the contradiction between old laws and new concerns:

• The judicial system has defined these kinds of antitrust questions in terms of their impact on the welfare of consumers. And while there is more to consumer welfare than price alone, in a practical sense, looking at prices (which are obviously important and also lend themselves to being measured in an objective way) has been the dominant strand of consumer welfare analysis. … The standard, in other words, isn’t that one company dominating a market is bad. It’s that it’s bad if a company’s market domination leads to bad outcomes for consumers.

So if modern monopolists create better outcomes for consumers, what’s the problem? These tech innovators make money, and consumers get cheap or free products. Well, when a company dominates its market as completely as these tech giants do, there are many problems. Monopoly firms dictate terms to suppliers and other companies in their supply chain. They engage in unfair trade practices, such as selling some products at a loss until competitors fold or sell out. They discourage start-ups from venturing into the market. They decrease competition and choice.

These problems, despite the clear benefits for consumers, are drawing attention from regulators and politicians.

• The European Union has fined Google several times ($10 billion so far).
• Facebook’s CEO was summoned last year to a hostile Congress.
• Just last week, the Supreme Court allowed a suit to go forward based on complaints that Apple has used its app store as a monopoly.
• Several presidential candidates are calling for oversight — or break-ups.

But how did we get here, and how have subscription business models pushed these big firms over the $1 trillion mark and into the public eye?

Apple

The computer maker has always valued its “walled garden” approach to design: Apple designs the hardware, the operating system, and, for many products, the software. But the old Apple computer line always allowed for other software makers to create and sell apps directly to consumers, with no intermediary. It still does, for Macintoshes.

But when Apple launched its iPhone, it took advantage of an opportunity to insert itself into the software maker / software buyer relationship. Any app developer who wanted to create iPhone apps would have to sell them in Apple’s marketplace, paying Apple a 30% cut. It is not exactly a strict SaaS model, but the lock-in, with the replacement cost of your iPhone serving as the subscription fee, is just as powerful.

That 30% fee is the key reason that Apple is being sued. The question is, does the Apple walled garden constitute a monopoly? Put another way, by making it hard to change platforms — you have to buy a new phone to do so, and move all your data over to it, not to mention apps that are hard to migrate to a new phone — Apple has incentivized iPhone customers to stay put.

Apple is working hard to make those incentives even greater with SaaS services. Here’s Jeremy Horwitz at Venturebeat:

• Subscriptions are becoming increasingly major sources of Apple’s “Services” revenue, and the company’s been openly working on two followups to Apple Music: a paid subscription service for Apple News, and a video subscription service for iOS devices and Apple TVs. Each is said to be Apple’s take on the popular all-you-can-watch streaming service Netflix, here with independent news organizations providing endless news and Apple funding a huge slate of original videos.

As Apple is pushing harder to lock in users and tie them more firmly into the Apple ecosystem, the company’s lawyers are arguing that you should believe them and not your own lying eyes. In a recent Apple statement, reported by the Verge, a spokesperson declares that existing alternative platforms make the suit moot:

• Developers have a number of platforms to choose from to deliver their software – from other apps stores, to Smart TVs to gaming consoles – and we work hard every day to make our store the best, safest and most competitive in the world.

And yet, Apple continues to entice users to stay within its walled garden with new subscription options.

Amazon

When this online department store was more known as a book and media seller, it distinguished itself from the competition by creating the Prime option. For an annual subscription fee, members gained free two-day shipping for all purchases. A historical look back at this creation of Prime, based on the accounts of Amazon execs at the time, reveals the rationale behind the strategy. Quoted in Vox, here’s CEO Jeff Bezos as recalled by former Amazon director of ordering Vijay Ravindran: “I want to draw a moat around our best customers. We’re not going to take our best customers for granted.”

Digging that moat — and making it hard for customers to swim the moat and visit some other castle — was a strategic decision that changed the way customers viewed the Amazon experience. It incentivized users to identify with Amazon and make the retailer the first stop in any online shopping expedition. According to Ravindran, “I think that completely changed the mentality. It was brilliant. It made Amazon the default.”

Later on, Amazon added value to its Prime subscription by adding video and music as a free add-on for subscribers. And as the variety and quality of the entertainment offerings improved, the service built loyalty.

Amazon used its market power to beat down competitors. Take the case of how Amazon crushed Diapers.com. As reported by Colin Lecher at The Verge, Amazon took a loss on baby supplies in order to force the company into a merger, and then shuttered the brand.

• To get the better of a competitor, a business drops the price of a product to below its cost to produce. The competitor, unable to beat the price, goes out of business. Then the company, now with a monopoly, raises prices, recouping the loss. … [But] the new breed of predatory pricers don’t necessarily need to raise prices to recoup their costs … They simply have to bet that, sometime in the future, their costs will drop – either because the technology for producing a product gets cheaper or because the scale of the business introduces new efficiencies. For consumers, little would seem to change, but the company would have cemented a dominant position in the market.

Under current interpretations of antitrust law, this is all legal. But Lecher writes that there is growing support for a different interpretation. Until then (and even after, frankly), Amazon will continue to lock up its customers by making them a subscription offer that is too good for them to refuse.

Microsoft

Once upon a time, Microsoft had a reputation not too dissimilar to the one Facebook has now. At CIO Dive, Samantha Ann Schwartz has the story:

• In 1997, Sun Microsystems CEO Scott McNealy was called to testify before the committee because he was one of the few souls in the tech community willing to take on Gates and the Windows-maker. McNealy wasn’t afraid. “Microsoft has the power today to exercise predatory and exclusionary control over the very means by which we access [the] internet,” said McNealy to the committee. “We think, left unchecked, Microsoft has a monopoly position,” enabling the company to break into other industries including finance, media and ISPs.

But, unlike Facebook so far, Microsoft wised up, reached an accommodation with the Justice Department, and made a strategic retreat. The company gave up its dreams of dominating the whole world and satisfied itself with dominating the corporate world. Relying on its operating system market power, the company evolved into a cloud computing provider and transitioned its powerful Office suite to a SaaS business model.

Look at how the company’s strategy has evolved just over the last three years:

(Source: Morgan Stanley, Microsoft, and rhipe via Statista)

What’s the difference between 2015 and 2018? The fall of traditional Office and the rise of subscription-based Office 365 and Azure.

The lock-in is that the company’s SaaS sell is founded on the familiarity and comfort corporate customers have in Microsoft products. At his Stratechery blog, Ben Thompson nails it:

• Make no mistake: the Microsoft optimism that is driving a (near) trillion dollar valuation is justified. … At the same time, the reason [Thompson’s emphasis] to use Microsoft is very much grounded in the past: Office documents are familiar, and Exchange remains the standard for enterprise email. The advantage of going with Microsoft is that everything works mostly as it has previously.

Insider Take

Shoppers love Amazon Prime’s fast, free shipping and quality video on demand. Corporate IT managers love Microsoft’s steadfast Azure and Office 365 offerings. And everybody loves Apple’s iPhone ecosystem. Through the use of these lock-in options — and by cleverly making customers happy to be locked in — these three tech giants have moved toward (and are continuing to move closer to) subscription-based modern-day monopoly power in their markets. Have they over-reached? Ask me in November 2020!