Pricing is Power

Malt Liquidity 86

Skewed Risk

Part of making money is understanding your risk/reward. In a trading strategy, this is nakedly obvious as your PnL over time will reflect the expectancy of your trades. In a business, it’s a little more illiquid and esoteric — you have to constantly be assessing the costs, upsides, downsides, and externalities of your various verticals. Take, for example, the institutional trading activities that led to the Volcker rule — prior to it, traders at banks were regularly (implicitly) allowed to bypass leverage limits so long as they made money. The upside? Make a huge trade, collect a massive cut as a bonus. The downside? No big deal! Get fired for violating risk policy, and maybe take gardening leave and find a new job. How about the bank though? The upside is correlated — maybe you’re making money on the trade that you wouldn’t have made otherwise, and have to pay some of it off as a bonus — but on the downside, your risk limits have been violated, which might lead to severely unexpected losses, and you’ll get fined/sanctioned for mismanaging consumer deposits. This, inevitably, is what led to trading losses like Jerome Kerviel’s along with the severe gating of what trading activities were allowed in banks — the upside was massive for the employee compared to the downside, so who wouldn’t have done otherwise? As such, the entire industry’s rules had to be rewritten.

As a terminally online, serial networker, I caught a few fellow friends in the MacBook class chortling over Twitter’s new API pricing:

Objectively, .25 cents an API call is absurd. But what I gleaned from this was an insight into Elon’s overall plans for Twitter.

Programmers in general are used to APIs being readily callable. While industry stalwarts like Microsoft and Apple have hidden away access to similar functions, ZIRP companies like Reddit and Spotify have gladly handed over API access. Theoretically, this has two benefits — one is that a service built off of the API helps onboard users, and the other is that a service could objectively add a usage that hasn’t been seen before by the company itself, adding another vertical. ZIRP companies were founded in the age of utopian “software will eat everything” thinking taking priority over hard reality like debt payments, fundamentally driven share performance, and financing.

Here’s the thing though — objectively Twitter is bleeding money, and it does not need to add to its network effect, given its stranglehold on the reporting feedback loop. It desperately needs to find a way to become profitable as a company. We know its ad business did not work from its history as a public company. Therefore, the only other thing of value that Twitter has is the network itself. Making people pay to be seen by their followers is step 1 — the service has high upside for people with lots of followers who are profiting from Twitter’s network while not compensating Twitter at all for providing the infra for doing so. The risk is all on Twitter, but what is the upside for the company as opposed to the individual for allowing large accounts to wantonly monetize their following? A pound of flesh must be handed over.

Step 2 involves cutting unnecessary infrastructure costs. I’ve experimented with plenty of APIs in the past, as have many aspiring programmers. Every single call we made was negative value for Twitter — we obviously weren’t creating anything for Twitter, but we were getting valuable practice on building our own resume skills. What upside did Twitter get? It’s the Jerome Kerviel situation with the minutest delta of upside optionality on the outcome. Running absolutely zero numbers, I’m sure if ~97% of the current Twitter API userbase was culled, it would be a big net benefit to Twitter in the short term — they free up engineers and compute cost and can work on the myriad of other issues they face.

However. This is where the pricing comes into play. Nobody is going to pay .25 cents an API call for practice, but there are definitely valuable services that do need access to the Twitter API to function. These people are obviously in a panic: the only possible reactions to prohibitive pricing are “fuck this I’m leaving” or “fuck I need to negotiate this down because what I built is too valuable to get destroyed.” Rather than going out and analyzing all the API apps himself — at a tremendous cost of time — Elon is making them come to him. It’s ludicrously efficient and forces hands very quickly. Elon can quickly assess the pitch from whoever comes to the table, fold them into Twitter if it’s worth it, and streamline something that on a percentage basis was a seriously negative vertical prior, completely shifting the value calculus.

This strategy is particularly useful because it can be applied to anything, really. Take a short squeeze as an example. It was objectively insane to buy GME at any surge price based on valuation. Yet if you buy it and see who has to buy to cover, you figure out immediately who you can squeeze and demand they come to the table and buy your stock out. The same strategy applied to HLF, Ackman, and Icahn. I’m sure services that allow fluid onboarding like AWS use a similar strat — allow people to build tools, and when they scale, ramp up the costs to the point where it’s cheaper for them to be internalized.

What’s unique about Elon’s strategy is how fluidly he seems to be pivoting the company away from a “failing ads business” into the first genuine attempt to monetize a social network directly. Facebook and Google never directly monetized their networks, but rather leveraged the size to prop up their ads business. This was never going to work for Twitter, and WhatsApp is more of an onboarding ramp to other profitable Facebook products than it is a monetizable network in and of itself. Twitter is taking the Bloomberg approach to social media — it has a thing of value, its network effect and reach, and it wants to gate its most personally profitable users from straight up costing it money. I remember a story from a trader I once drank with where the front office traders were so annoyed at having to use a chat program that wasn’t Bloomberg with their support staff that the bank caved and purchased Bloomberg for everyone.

The cost of liquidity is reflected by the demand for immediacy. For too long, Twitter has been a provider of liquidity at a massive cost to itself. Optionality aside, it will be interesting to see how the service changes.