MSFT Strategy to use AI

 Economist:  Microsoft's Push into AI

ChatGPT-4 Summary:

Shift in Strategy 

For years, Microsoft promoted its office software for office tasks such as writing reports and creating presentations. Now, Microsoft aims to automate these processes with AI.

Copilot - The AI Wizard: At its Redmond HQ, Microsoft showcased its latest AI tool, the “Copilot”. This chatbot can automatically summarize files, edit its summaries, answer questions about the content, find emails on specific topics, and even create PowerPoint presentations.

The Future: The capabilities of "generative" AI, like the one powering Copilot, have the potential to revolutionize desk jobs and signify Microsoft's future direction. Through its investment in OpenAI (known for ChatGPT, a famous AI chatbot), Microsoft is integrating advanced AI into its products.

Expanding Copilot's Reach: Microsoft plans to integrate the Copilot not only in its office software (now called "Microsoft 365") but also in Windows OS, enabling the system to modify settings, create images, and summarize web pages. The AI-driven feature will also find its way into Microsoft's sales software, HR tools, and even its search engine, Bing. Microsoft is, therefore, integrating AI across its product range.

The Business Implications

Potential Growth: Microsoft's AI-driven approach can significantly alter work for the billions of Microsoft 365 and Windows users. This could attract more customers, charge them higher rates, and even potentially direct more business towards Azure, Microsoft’s cloud business. Success here could allow Microsoft to surpass Amazon Web Services, increasing its valuation and possibly making it the world's most valuable firm, challenging Apple's current position.

Opportunity and Risk: The aggressive push towards AI signifies one of the most significant investments in the technology by any company. However, Microsoft's large capital expenditures, expected to rise sharply to cater to the AI tech and new data centers, is a gamble. While the potential benefits are massive, AI tools like Copilot still have issues to address. Moreover, tech giants, especially Alphabet (Google's parent), pose significant competition.

Historical Context: Microsoft dominated in the 1990s thanks to the Windows OS. However, a period of stagnation occurred before Satya Nadella took the reins in 2014, shifting the focus from Windows to Azure and the cloud. Nadella also opened up Microsoft software to other operating systems and invested heavily in AI, especially through partnerships with OpenAI.

Revenue Streams: Microsoft's growth now relies primarily on Azure, Microsoft 365, and cybersecurity, with the latter two accounting for about a quarter of its revenue each. Azure has been inching closer to AWS in market share. The firm also sees growth potential in its video-game sector, especially with the anticipated acquisition of game maker Activision Blizzard.

Advantages and Market Position

AI Integration Edge: Microsoft's suite of software products, combined with its early adoption of AI (thanks to its partnership with ChatGPT and OpenAI), places it ahead of competitors. Surveys indicate a preference among IT managers and startups for Microsoft's AI solutions over those of rivals like AWS or Google Cloud Platform.

Ecosystem Around OpenAI's GPT-4: Industry experts observe an ecosystem forming around OpenAI’s GPT-4 model, with consultants specializing in its tools and software vendors building tailored programs using OpenAI’s frameworks.

The article underscores Microsoft's strategic pivot to harness the power of AI in shaping the future of work and its bid to reclaim its position as the world's most valuable company.

The difficulty with Monopolization or Abuse of Dominance Cases: FTC vs. Amazon

FTC has brought a monopolization or abuse of dominance case against Amazon.  The main difficulty with these cases is that for every anticompetitive mechanism (or claim), like raising rivals' costs, there is a also pro-competitive one (or justification), like elimination of double markups, more easily understood as incentive alignment.  Explaining or estimating the indirect anticompetitive effects is not only more difficult and circuitous, but to infer the causal effects of Amazon's behavior, one needs a counterfactual or relief if the FTC wins their case.  However, the FTC will be reluctant to spell this out as it would make their case falsifiable. 

First Define the Market:  To win a monopolization case, the FTC has to define the "relevant market" more narrowly than total retail where Amazon has a 10% share, and more narrowly than online retail where Amazon has a 38% share:

For Amazon to look dominant, the FTC had to invent new terms such as the online superstore market that serves shoppers and the online marketplace services purchased by sellers. [CITE: Reason]

Assessment:  These markets may seem gerrymandered and may be hard to defend.

Abuse of Monopoly Power: Once the FTC defines the markets in which Amazon has a monopoly position, the FTC has to show that Amazon's business practices harm competition, but: 

• Amazon offers consumers low prices, and an alternative to brick & mortar stores.
• Amazon's infinite shelf space gives 3P sellers from all over the world an easy way to sell to consumers from all over the world.
• Amazon's online marketplace has induced competition from rival online sellers, like WalMart and Shopify.

Claim 1:  Amazon is making third party (3P) sellers pay for unnecessary services, like FBA, (Fulfillment By Amazon) [CITE: NBC]

Assessment:  The obvious justification for FBA is that it ensures high quality service (fast, reliable, one or two-day service, with great customer service on returns and refunds).  In addition, sellers can fulfill their own orders.  

Claim 2 Self-Preferencing:  "Pushing Amazon's own products [1P] when it knows others [3P or 'third-party'] are better quality" [CITE: NBC]

Assessment:  If true, does Amazon have the incentive to self preference?:

• the success of Amazon's marketplace depends on a having a wide selection of low-priced 3P products; 
• Amazon earns a commission on 3P products sold on its platform, so disadvantaging 3P products would carry an opportunity cost; and
• Amazon started out as 100% 1P but opened its marketplace up to 3P sellers because it was profitable.  What has changed?

Claim 3: Amazon buries search results from 3P sellers who sell for less on other platforms.  [CITE: NBC]

Assessment:  If true, the obvious justification is that Amazon wants to protect the reputation of its marketplace as having the lowest prices.  This intra-brand restraint makes Amazon's marketplace more attractive, which increases inter-brand competition, with other retailers.

SOME RELATED ACADEMIC WORK:

• Willem H. Boshoff, Luke M. Froeb, Wihan Marais, Roan J. Minnie, Steven Tschantz. Bargaining Competition and Vertical Mergers: The Problem of Model Selection, Review of Industrial Organization (forthcoming). 
• Cooper, James, Luke Froeb, Daniel O'Brien, and Michael Vita, Vertical Antitrust Policy as a Problem of Inference, International Journal of Industrial Organization, 23 (2005) 639–664. SSRN 
• Comment by Frederick Scherer (2005) 
• Comment by Ralph Winter (2005) 
• Reply by authors (2006) 
• Rejoinder by Ralph Winter (2006)

TRUTH IN BLOGGING: I sometimes consult for Amazon.

Chapter 6, Promotional Pricing Question

QUESTION:  In a supermarket, an end-of-aisle promotional display typically makes the demand more elastic (see link) by making customers more aware of price differences between products.  

Specifically, suppose that a promotional display changes the price elasticity of demand for a good from -2 to -3. If the normal price is $10, what should the promotional price be? 

ANSWER: 

• STEP 1: Use the optimal pricing formula from Chapter 6 to solve for Marginal Cost (MC) at the pre-promotional elasticity of -2.  
• (PRICE-MC)/PRICE=1/|Elasticity| 
• Margin=Target Margin 
• ($10-MC)/$10=1/2 
• $10-MC=$5 
• MC=$5 
• STEP 2: Use the optimal pricing formula to solve for the new price at elasticity of -3
• (Price-$5)/Price=1/3 
• 3*(Price-$5)=Price
• 2*Price=$15
• Price=$7.50
• CHECK ANSWER:  
• ($7.50-$5)/$7.50=1/3
• $2.50/$7.50=1/3
• 3*$2.50=$7.50
• $7.50=$7.50

The ar-thar-i-tis defense to price fixing

In the late 1980's, I was working at the Antitrust Division of the U.S. Dept of Justice, when I was sent to Iowa to support a price-fixing case against the only two gas stations at the same exit on a highway.  Every morning, one station owner would call up the other and ask "what are you charging for gasoline today?"  

He would answer, e.g., "$1.99," and then the first owner climbed up a ladder to change the numbers on her sign to match that price.  

These kinds of conversations are thought to be so bad that they are per-se illegal, i.e., there is no justification for having them other than to fix prices.  If convicted of criminal price fixing, the sentence is one-to-ten years in prison.  

This particular conspiracy was discovered when a disgruntled ex-employee reported it to the Local US Attorney's office, who then told us.  The FBI tapped their phones, and we recorded them having the same conversation each morning.   And just to make sure, we "flipped" the second station owner by offering immunity in exchange for his testimony against the "ring leader," the old lady who initiated the call.  Then I bought a blue pinstripe suit and flew out with the rest of the trial team to Iowa to break up the conspiracy and put the bad guys in prison.  

At trial, we played the recordings, explained the law, and rested our case.  

When lanky defense attorney came out in a wrinkled, white linen suit, looking and speaking suspiciously like Mark Twain.  He called his first and only witness, the "alleged ringleader of this so-called conspiracy."

Once he established that if they charged different prices, the station with the higher price would not get any customers, he asked his client "Ms. Smith, can you tell me about your ar-thar-i-tis?"

"Oh, it hurts so bad that I can barely make it to the top of the ladder."

"Now you know that you are not supposed to discuss prices with your competitors?"

"I did not discuss prices--but my ar-thar-i-tis hurts so bad that I can climb up only once a day.  If I don't make that phone call, I can be stuck with the wrong price all day.  

The jury deliberated an hour when the foreman came out to deliver the verdict, wearing ill-fitting blue jeans over which you could see the top of his inter-gluteal crevice: "not guilty on all counts."  We got "home-fried."

Is the DOJ case against Google stupider than the FTC's tech cases?

The Dept of Justice (DOJ) is upset that Google pays Apple to be the default search engine on iPhones.  If the DOJ wins their case, the "relief" DOJ would seek would proscribe such payments, just as the EU did.  According to one observer, 

"In the wake of the European Commission’s 2018 Android decision, Google had to implement a choice screen (starting in 2019) on Android devices in Europe (which had confined the market to Android devices). No more Google default: users of new devices with the choice screens are presented a half-dozen choices—including Google and obvious alternatives—upon startup. Placement is shuffled at random."

Did this relief change Google's "illegally" acquired & sustained dominance in mobile search?

Well, not exactly.  Google’s share of general search on mobile phones in Europe is still greater than 96%.

QUESTION: So, why would Google pay for something that it would get anyway?  

TENTATIVE ANSWER: Apple has valuable real estate and they are creating ex-ante competition among search engines for the right to use that real estate.  But if search users are going to switch to Google anyway, even if, e.g., Bing outbids Google, then maybe the ex-ante competition is not very fierce.  I wonder how much Google makes on search ads served up on Apple devices, and how much Google pays Apple for the privilege.  

QUESTION: And why would the DOJ ask for relief they know will not work?

TENTATIVE ANSWER: DOJ doesn't care about ex-ante competition.  The see Google's big share of search after they won the ex-ante competition, not as a indicator that the  the most valuable search engine won the auction, but rather as an indicator that something is wrong--or at least could be made better by government interventiion.

Is the opportunity cost of net-zero too high?

For Sweden it is:

It cited the tough economic climate along with a plunging krona, expecting to also fall short on other targets for protecting the environment.

Prosecutorial Discretion: Attorney General Edition

In the late 1980's, I went with a friend to help her work the Ambassador's Ball at the French Embassy, a pay party and charity auction to support MS research.  I bought my first tuxedo and showed up early to sign people in and help set up.  After an hour or so, our job was done and we went inside to join the party.  

We grabbed a drink at the open bar, and into a big room containing the items being auctioned off: cases of rare wine, catered dinners, and vacation homes in exotic locales.  My favorite, or at least the one I might have bid on but for the money, was a week at a Chamonix chalet.  In front of each item was a lined piece of paper where people wrote down their bids.  

As the night wore on, I noticed two couples actively bidding for the chalet.  One couple would watch the other write down a bid, wait a while, and then walk over and bid again.  This went on for three or four bids, until I noticed the two couples talking to one another.  

At the time, I worked as a staff economist at the Antitrust Division of the US Dept. of Justice whose mission is to protect competition by challenging anti-competitive mergers and prosecuting price-fixing conspiracies.  Even talking about prices is viewed a criminal conspiracy subject to a prison term of up to ten years.  

I had worked on and written about a number of bid-rigging conspiracies--dealers at antique auctions, loggers at Forest Service timber auctions, and frozen perch sellers at Navy Procurement auctions--and I was excited to actually witness one. 

The event was chaired by Ursula Meese, whose husband Ed was my big boss, the Attorney General.   I saw him standing by himself in the center of the room, so I walked over, showed him my badge--that's what I liked to call my work ID--and told him what was going on. 

"Do you want me to take 'em down?" I asked.  

He smiled and said "Book 'em Danno."  [reference for those too young for the allusion]

========

NOTES: The Economist has reported on my articles on bid rigging albeit with a small mistake.  

Middle panel of my first-day class slide shows Attorney General Meese and me in the Reagan Justice Dept.  

How would you align the incentives of a Data Protection Officer with the goals of the organization?

 In a previous posts, we have blogged about the onerous EU privacy rules.  Just came across another, a GDPR Data Protection Officer or DPO.

According to Article 38, other employees in the organization aren’t allowed to issue any instructions to the DPO regarding the performance of their tasks. So, not only does the DPO have wide-ranging responsibilities, but the position is shielded from potential interference from the organization.

Wow. What is the performance metric, and are you prohibited by law from tying pay to performance as it could constitute "interference?"

Capital Gains Taxes destroy wealth in these EU countries

If you tax something, you get less of it.  In EU countries without capital gains taxes (Switzerland, Belgium, Luxembourg, Turkey, Slovenia, Czech Republic and Slovakia), an investment that costs $100, but returns $150 after five years has an annualized Internal Rate of Return (IRR) of 8.45%.  In other words, this investment is not profitable unless your cost of capital is less than 8.45%.

For the countries with the highest capital gains rates, Denmark (42%), Norway (35.2%), and France (34%), this investment won't get made unless capital costs are less than 5.2%, 5.7%,  and 5.9%, respectively.  

BOTTOM LINE:  the higher the capital gains rate, the smaller the investment, and the poorer is the country, compared to what it would be without a capital gains tax.

In-class question (Ch1): Wells-Fargo

QUESTION:  In 2016, Wells Fargo was fined $185 million for fraudulent sales practices. The bank's employees had opened as many as 2 million unauthorized bank and credit card accounts in customers' names. Figure out what the problem is and select the best way to fix it.   

 1. Let someone else make the decision.

 2. Change the incentives.

 3. Give the decision-maker more information. 

DEBRIEF (LINK): 

1. Let someone else make the decision: Replacing the CEO and firing thousands of employees was part of the response, but it doesn't address the root problem - the sales-oriented incentive system. 

 2. Change the incentives: This would be the most effective solution. After the scandal, Wells Fargo had to review and change its sales practices and incentive systems to focus on customer satisfaction rather than solely on sales volume. 

 3. Giving the decision-maker more information: This alone would not have been sufficient. The executives were aware of the aggressive sales culture. The issue was the incentive system, which encouraged employees to open unauthorized accounts. 

How Saudi Aramco, world's largest oil company, became "Green"

Irony is my favorite kind of humor!  From Bloomberg:

The unlikely tie-up between Aramco and ESG began with the creation of two subsidiaries — the Aramco Oil Pipelines Company and the Aramco Gas Pipelines Company. Aramco sold 49% of the shares in each unit to consortiums led by EIG Global Energy Partners LLC and BlackRock Inc., respectively. These investors used bridge loans from banks to fund those transactions.

In order to generate cash to repay the bank loans, the EIG and BlackRock consortiums created two special purpose vehicles: EIG Pearl Holdings and GreenSaif Pipelines Bidco, both registered at the same Luxembourg address. These SPVs then sold bonds, which, since they had no direct links to the fossil-fuel industry, ended up getting an above-average score in a widely-used JPMorgan Chase & Co. sustainability screening based on third-party ESG scores.

From there, the bonds made their way into JPMorgan’s ESG indexes, which are cumulatively tracked by about $40 billion of assets under management. Investors in the SPV bonds include funds managed by UBS Group AG, Legal & General Investment Management and the investment arm of HSBC Holdings Plc.”

BOTTOM LINE: if you cannot measure it (ESG), you cannot control it.

What is a debt coverage ratio, and how does it affect apartment rents in Nashville ($1880)?

 From investopedia:

• The debt-service coverage ratio (DSCR) measures a business’s cash flow (Net Operating Income) divided by its debt payments, including principal and interest. 
• Lenders use a DSCR between 1.15 and 1.5 to determine whether to make a loan to a developer.

Here is an example, involving the cheapest loan available.

• A Nashville builder can build apartments for $167K/unit= $150K(construction) + $17K(land)
• FHA is willing to lend at $167K at 6% for 40-years, resulting in a debt payment of $986/month.  
• With FHA's DSCR of 1.15, the builder must make at least $1134/month in Net Operating Income (NOI) to qualify for a loan.  
• With 7% vacancy the expected NOI increases to $1213/month
• Add operating cost to NOI to get Rent=$667+$1213=$1880/month 

New apartment supply will enter the market when Nashville rents rise 20% to $1880.

HT:  Bill H.

Lobster Roll Strategy

FORBES:

He began with the fact that he could not get a decent lobster roll in Manhattan. Everything was off, Holden said. The price was too high, 30 dollars. The lobster meat was inferior with fillers, masks and diluters “to essentially hide the fact that the lobster meat wasn’t as high quality as it could be.”

Then there was the white table cloth service – ridiculous, and as far from the quintessential Maine lobster shack as you could get.

“I’m not a big fan of mayonaisse,” Holden added. “I really struggled to find a lobster roll in the city not drowning in mayonaisse.”

Here’s the recipe for a true Maine-style lobster roll: chilled meat, somewhere in the realm of a quarter-pound of fresh knuckle claw lobster meat; a New England top-split bun, which serves purely as a vessel for the super high-quality lobster meat.

Shave a little butter onto the sides of the bun, toast it golden brown, add a little mayo for texture, some secret seasoning and celery salt to accent the lobster, a little warm lemon butter to bring it all together. That’s all you need.

“That literally is the key to the program,” Holden said. “Once you start trying to do anything other than put your star of the show facing forward, you’re playing from behind. You have to lead with your best food forward. Lobster is the star of the show.”

...

The first day, Luke’s sold 500 lobster rolls. They were expecting to sell 100. Holden’s dad, Jeff, drove down more lobster meat from Maine overnight for the next day.

Then geographic expansion and vertical integration:

Ten years later, Luke’s is still in the East Village in its original location, but it also has 30 more locations in Maine, Boston, New York, Philadelphia, Washington, D.C., Chicago, Las Vegas, and Miami, plus 10 locations in Japan, and two locations in Taiwan.

Luke’s also has one of the largest lobster production facilities in the United States in Maine, where it manages the lobster for Whole Foods, among others. Luke’s Lobster Seafood Co. processes about 5 million pounds of lobster annually and 2 million pounds of Jonah crab.

HT: Giselle

Synthetic Diamond Disruption

Prices of synthetic diamonds have fallen dramatically.

About five years ago, lab grown gems sold at about a 20% discount to natural diamonds, but that has now blown out to around 80% as the retailers push them at increasingly lower prices and the cost of making them falls.

Synthetic gems have been around for decades, but it appears that their costs have recently fallen. The resulting price decreases have increased synthetic diamond demand considerably. This is causing the longtime incumbent monopoly on natural diamonds, De Beers, no small amount of pain.

In June 2022, De Beers was charging about $1,400 a carat for the select makeable diamonds. By July this year, that had dropped to about $850 a carat.

Will DeBeers become the most recent in a string of now defunct market leaders? We are used to seeing digital disruption of traditional retailers, e.g., Blockbuster Video, Borders Bookstores, and Encyclopedia Britannica. It is harder to find recent non-Internet related examples.

HT: Marginal Revolution

Should the Justice Dept be more concerned with Google's complaining competitors or their enthusiastic customers?

Judge Mehta:

A dominant firm like Google does not violate the law, however, merely because it occupies a monopoly market position. It must act in a manner that produces anticompetitive effects in the defined markets. [e.g., that harm consumers].

Mozilla CEO testifying on behalf of Google (page 109 of MSJ transcript):

...consumers are choosing Google. We’re making search easy for them, and we added choice in a product in a way that no one else had or even thought of. We’re making it easy. ...

In response, the Justice Dept. is trying to exclude testimony about Google's quality. They seem to miss the irony that this makes them seem as if they are more concerned with Google's complaining competitors than their enthusiastic customers.

UDPATE:  the judge ruled against the DOJ, in essence telling them they should be more concerned with what Google's customers are saying.

Dollar General strategy shifting, but not too much

 From WSJ:  

• 1000 new stores in rural areas, 
• Target demographic <$40,000 income/year, 
• Its workers earn about $16,000/year.
• Experimenting with upscale brands, DGX