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Big Tech Set to Face Margin Compression in Coming Years

Just one presidential election cycle past, Democratic candidates and grandees were crowing about their deep ties to Silicon Valley and the national tech ecosystem. This time around, things are definitely different.

Now there are several presidential candidates, most notably Senator Elizabeth Warren, calling for an all-out trust-busting effort directed against the biggest tech companies, including Alphabet Inc. (NASDAQ:GOOG)(NASDAQ:GOOGL), Facebook Inc. (NASDAQ:FB) and Amazon.com Inc. (NASDAQ:AMZN).


A bad breakup

Big Tech and the Democratic Party are going through a very nasty and public breakup. The change has been extremely abrupt. On Oct. 4, Politico's Nancy Scola also commented on this remarkable shift:


"Back in 2016, the Clinton campaign was very eager to build bridges with Facebook & Google. These are not those times. This sets up a pretty epic battle: a potential Democratic nominee at war with some of the most powerful forces in the world. We haven't really been here before!"



The shocking speed and severity of the breakup was also reflected in a Sept. 18 New York Magazine article:


"While it took the 2008 financial crisis -- and the decade of fallout that followed -- to tear Democrats from Wall Street, the onset of their breakup with Silicon Valley happened much more abruptly. This decoupling reflects the tarnished reputations of once-gleaming companies like Facebook, Google, and Amazon, still widely trusted but increasingly damaged, especially on the left, by public furor over election interference, monopolistic practices, and labor policies. It reflects, too, a more populist Democratic Party, which sees tech monopolies not as the swaggering future of corporate America but as a target for a revived antitrust movement."



It did not have to be this way

The rapid rise in animosity toward Big Tech among Democrats is shocking, but not necessarily terribly surprising in itself. Indeed, the issues of election integrity and privacy were always bound to drive some wedges between tech companies and politicians. There is a certain degree of tragedy in the whole story since, as New York Magazine reflected last month, it did not have to be this way:


"This isn't just an ideological story or an inevitable one. Some blame for the breakup lies with the calculated maneuvers of just a few politicians on the rise and the blunders of a few big-money techies looking to play politics, with neither party willing to pay the deference the other felt was required. Democrats might've been a lot more willing to forgive the sins of Big Tech if its executives had performed even the smallest show of political humility or contrition in their responses to political scandals or in their outreach to candidates."



Tech executives' apparent unwillingness to play ball during appearances before Congress has helped to curdle anger among politicians on both sides of the aisle, though the anger has clearly boiled over more among those on the left-leaning side. As the Wall Street Journal observed in early September, however, tech companies can no longer afford to uphold their historical "hands off" approach to platform management:


"The 'we are just a tech platform' excuse is no longer cutting it. Facebook has been investing aggressively this year to bolster safety on its platform, including on its Marketplace, where last month The Wall Street Journal found disguised gun sales, despite a ban. The company has spent the better part of the last two years getting lashed by regulators, lawmakers and the press over disputes that can mostly be boiled down to the legitimacy of content posted on its site. Now it is Amazon's turn. A Wall Street Journal investigation last month found thousands of unsafe items listed on Amazon.com, mostly from third-party merchants. Amazon says it has tools in place that have worked to block 3 billion listings last year alone. But the company will likely have to do more, given the increased scrutiny it now draws."



Prepare for margin compression

Whether or not Big Tech companies end up facing serious antitrust actions in the coming years remains to be seen. Silicon Valley's increasingly tenuous relationship with the Democratic Party certainly makes the prospect appear more likely. However, antitrust enforcement is not the only issue. Platforms' need to be more hands-on will also cost. This could have serious implications for the margins of all tech companies, though, as the Wall Street Journal discussed last month, lower-margin companies like Amazon will face the harshest challenge:


"In Amazon's case, the e-tailing business offers much thinner profits than that of online advertising, leaving less cushion to absorb higher costs. Amazon's operating margin of 6% over the last four quarters pales next to 34% for Facebook and 26% for the core Google business. More stringent quality control could deprive customers of some apparent bargains, driving them back into the arms of traditional retailers. Prepare for a margin squeeze at tech platform companies."



Tech companies will not need to be broken up for investors to get dinged. The increasingly onerous cost of managing platforms will eat into margins, even if some of the costs are passed on to end consumers.

Disclosure: No positions.

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This article first appeared on GuruFocus.