Commercial and geopolitical forces are threatening to fracture the internet into competing regimes, making it harder for companies to operate across borders and potentially limiting their growth. We explore the implications for investors.
In 1996, the American writer John Perry Barlow published a paper titled “A Declaration of Independence of Cyberspace”, which summed up the idealistic view of the internet that prevailed as the technology became mainstream.
“Governments of the Industrial World, you weary giants of flesh and steel, I come from Cyberspace, the new home of Mind,” Barlow wrote. “On behalf of the future, I ask you of the past to leave us alone. You are not welcome among us. You have no sovereignty where we gather…Your legal concepts of property, expression, identity, movement and context do not apply to us.”1
A quarter of a century on, these words look somewhat quaint. While the coronavirus pandemic has highlighted modern society’s reliance on online tools, it is also clear that the freedoms of the early internet have been sharply curbed.
Big tech companies have sectioned off cyberspace into “walled gardens”, where users are corralled, profiled and bombarded with advertisements. Governments have wrested back control of online spaces with firewalls and surveillance technology.
The result is no longer a frictionless platform but an increasingly fractured and fragmented realm. Global companies must adapt their operations to different regulatory regimes and may even be barred from some countries altogether, due to governments’ efforts to protect their “cyber sovereignty”. These trends bring new challenges and uncertainties for investors.
The infrastructure of the internet was built by Silicon Valley engineers, working with technology inherited from the US government’s military projects.2 But it did not become the global communications system we know today until computer scientist Tim Berners-Lee invented the World Wide Web in 1989.
Tim Berners-Lee wanted the web to be open and accessible
Berners-Lee wanted the web to be open and accessible. But for authoritarian governments, the use of online messaging in fomenting civil unrest posed a direct threat. China developed a formidable “Great Firewall”, which limits access to websites the Communist Party deems subversive, and other states such as Russia and Iran followed suit.
Companies also played a role in the balkanisation of the network. While they benefited from the globalisation of the internet and rising numbers of potential customers, technology firms sought to keep users on their own platforms, limiting the interoperability of software so they could monetise a captive audience using targeted advertising algorithms.
US vs. China
In a 2019 paper, “The Four Internets: The Geopolitics of Digital Governance”, academics Wendy Lee and Kieran O’Hara argue the internet is being carved into competing systems led by various governments or private entities. And the most prominent contest is between the US and Chinese models of the internet.
The internet is being carved into competing systems led by various governments or private entities
Tensions between the two powers escalated in 2017, when the Trump administration slapped tariffs on Chinese goods, ostensibly to rectify a trade imbalance. Technology was key to the dispute: China stood accused of “forced technology transfer (FTT)”, or the theft of intellectual property from American firms.3
The US-China relationship has soured further during the pandemic, and the political stand-off has harmed the international ambitions of two innovative Chinese mobile platforms: Tencent’s WeChat and TikTok, a video streaming service developed by Beijing-based ByteDance.
In August 2020, Trump signed an executive order that imposed commercial restrictions on both apps and ordered ByteDance to sell TikTok’s US operations, due to concerns over user data collection (ByteDance appealed the decision, and as of January 2021 TikTok was still available in the US).4
“TikTok created a genuinely innovative artificial intelligence-driven platform and became the first emerging market internet company to make substantial inroads in developed markets. But this arguably happened at the wrong time given the geopolitical situation and the extra level of scrutiny now on this sort of business model,” says Alistair Way, head of emerging market equities at Aviva Investors.
Proxy battles and national champions
Chinese firms blocked from doing business in the US are increasingly looking for opportunities elsewhere. China’s Digital Silk Road initiative offers cheap financing for poorer countries, many of them in Africa, to develop their internet infrastructure using loans from Chinese banks and hardware provided by Chinese companies such as Huawei.5
US and Chinese firms are vying for customers in third countries
Meanwhile, both US and Chinese firms are looking to make up for their lack of access to each other’s markets by vying for customers in third countries such as Indonesia, Thailand and Vietnam, whether through partnerships with local companies or by directly offering their own services.
But in these markets, too, the splintering of the internet into national regimes is apparent, and domestic firms have been able to fend off competition by leveraging their expertise in sectors such as logistics and e-commerce.
The mobile-led internet model in emerging markets has powered a trend for ‘verticalization’, which deepens the splintering effect. Rather than access a search engine on a web browser, people in emerging markets increasingly seek out products and services using dedicated apps. This can create barriers for global tech companies hoping to generate advertising revenue on all-purpose platforms, argues Mikhail Zverev, head of global equities at Aviva Investors.
Future of the internet
Tighter regulations may force tech companies to spend more on technology or human labour to moderate content on their platforms. As operating expenses among tech companies tend to be high even before these added outlays – 40 per cent of total revenue in 2019, in Facebook’s case – any increase in R&D and labour costs may have a material impact on profit margins, says Louise Piffaut, ESG analyst at Aviva Investors.
While few expect the deep technology of the internet to shift in such a way as to make regional networks incompatible, each regime is likely to continue to become more distinct in legal and regulatory terms.
Big Tech firms will need to tread more carefully as concerns over content and data ownership grow
For now, the direction of travel seems clear. In the US and especially Europe, Big Tech firms will need to tread more carefully as concerns over content and data ownership grow, potentially opening up opportunities for platforms that offer better security and data-privacy protections.
These same concerns over privacy will limit the overseas growth of China’s internet behemoths in the West. But behind the Great Firewall, they will continue to develop innovative systems and may outstrip Western firms in areas such as artificial intelligence thanks to their unfettered access to a wealth of user data. In other emerging markets, companies that can attract mobile users to vertically integrated platforms will be able to resist incursions from global internet firms.
Some experts argue a splinternet could create a more diverse internet ecosystem, offering users in different markets a more tailored, localised service that better suits their preferences. But such a system would look very different from the limitless universal space that John Perry Barlow and Tim Berners-Lee envisaged.