Kinsman Oak Capital – Alphabet/Google: Natural Monopoly Would Cease To Exist

Summary:

• Alphabet Inc. faced controversy over AI tool Gemini, generating historically inaccurate images with extreme political leanings.
• CEO Sundar Pichai addressed internal culture issues and emphasized the importance of objectivity in providing information.
• We are again encouraged Sundar Pichai envisions the creation of an artificial intelligence solution that strives to provide objective and apolitical information to its end users or, at the very least, maintains the perception of doing so.
• We do not believe a natural monopoly would exist under purely free market conditions.

The following segment was excerpted from this fund letter.

Alphabet Inc. (NASDAQ:GOOG,NASDAQ:GOOGL)

Alphabet, a longtime holding in our Fund, stirred up considerable controversy earlier this year when the company released their proprietary AI tool called Gemini to the public. Suffice it to say, the images generated were historically inaccurate and the extreme political leanings of its creators were not even remotely subtle.

On the one hand, we decided to maintain our position and do not expect this event to negatively impact near-term results. On the other hand, we also believe this poses a serious risk to the incredible economic moat surrounding its core search business and early warning signs for the potential erosion of that moat are worth paying close attention to.

Alphabet was quick to suspend the use of Gemini and went into full damage control mode after the botched rollout. In an effort to mitigate reputational damage, the company cited poor training models, apologized for its shortcomings, and admitted that they “definitely messed up.” Despite the official theoretically plausible explanation, we suspect their artificial intelligence product is working as designed and the outputs generated were exactly as intended, reflecting a specific ideological agenda of Alphabet’s employees.

CEO Sundar Pichai, published a blog post titled Building for Our Future AI which outlined some internal operational and structural changes, and more broadly discussed his vision for artificial intelligence. Below are two excerpts from the last paragraph that particularly stood out to us (emphasis added):

1. We have a culture of vibrant, open discussion that enables us to create amazing products and turn great ideas into action. That’s important to preserve. But ultimately, we are a workplace and our policies and expectations are clear: this is a business, and not a place to act in a way that disrupts coworkers or makes them feel unsafe, to attempt to use the company as a personal platform, or to fight over disruptive issues or debate politics. This is too important a moment as a company for us to be distracted.

2. We have a duty to be an objective and trusted provider of information that serves all of our users globally. When we come to work, our goal is to organize the world’s information and make it universally accessible and useful. That supersedes everything else and I expect us to act with a focus that reflects that.

The first excerpt clearly addresses Alphabet’s severe corporate culture issues. We are encouraged Sundar Pichai recognizes he is responsible for running a business and employees need to be mission-oriented at the office. However, extreme cultural issues are exceptionally difficult to fix. Presumably the organization has layers upon layers of middle management filled with individuals who share the same radical political beliefs. How do you force an overwhelming majority of activists to be more moderate?

Disney (DIS) is dealing with similar internal issues that have already had meaningful negative consequences to business performance. Elon Musk reportedly had to fire approximately 80% of employees after acquiring Twitter, partly due to inefficiencies and because the business was hemorrhaging cash, but also partly due to ideological incompatibilities. The point is, recognizing it is one thing but executing a turnaround is more challenging.

The second excerpt addresses the inherent biases programmed into Gemini and perhaps other Alphabet products, including legacy search. We are again encouraged Sundar Pichai envisions the creation of an artificial intelligence solution that strives to provide objective and apolitical information to its end users or, at the very least, maintains the perception of doing so. Again, this is easier said than done, but this blog post gives investors some indication that the management team is aware of potential reputational damage and is focused on preserving the valuable moat the business has spent decades building.

Artificial Intelligence & Competitive Advantages

Our perspective is that any competitive advantage AI provides will eventually have less to do with raw processing power or the calibre of programming embedded within the code itself. Instead, the competitive advantage will be determined by the degree of perceived bias sprinkled into the results. End users will gravitate towards AI programs they can trust. In other words, users will prefer when the output generated is compatible with their preexisting and often subjective interpretation of reality.

Alternatively, we can envision a future where AI becomes heavily regulated. In such a scenario, we assume winners and losers will be selected based on the preference of whichever lawmakers and politicians are responsible for writing and enforcing applicable policy. In either case, we do not believe a natural monopoly would exist under purely free market conditions.