Whoever Generates the Demand Captures the Value

Last week we talked about the death of the middle -- this week we’ll talk about the death of middlemen.

While these sound similar, they’re actually quite different. The “death of the middle” is the idea that the internet creates a bifurcation between mega hits on one side, and the long tail on the other. In other words, the internet creates a barbell effect: we see both consolidation and fragmentation. Or, more precisely, aggregation and specialization.

The “death of the middlemen” however, is the idea that whoever generates the demand captures the value, and middlemen get commoditized as markets become more efficient. Like the barbell bifurcation discussed last week, this has ramifications for nearly every industry.

Pre-internet, middlemen thrived because they controlled supply. In retail, middlemen controlled shelf-space. In news, newspapers controlled publishing. And in music, record labels controlled distribution. So in this world, retailers, newspapers, and record labels were literal kingmakers, because without these middlemen, consumers wouldn’t have access to the stars. Middlemen enabled producers to reach their customers, or even create the product in the first place.

The internet changed all that. It provided a way for anyone to create and distribute products without depending on middlemen, and, in some ways, allowed creators to circumvent middlemen altogether.

Ben Thompson described this phenomenon in his signature aggregation theory. Pre-internet, you captured profits by controlling supply. Now, post-internet, you capture profits by aggregating demand.

The internet made distribution free and transaction costs zero, thus making it viable for a distributor to integrate with end users at scale. In other words, the internet disintermediated the supplier -> distributor -> end user relationship by allowing digital content to be aggregated & delivered directly to the end user. (ie. “DTC”)

Further, the internet made the marginal cost of distribution go to zero, implying that adding one additional customer is as simple as adding one more row in a database. It’s virtually free. This means the best companies win by providing the best experience, which earns them the most consumers/users, which attracts the most suppliers, which enhances the user experience in a virtuous cycle.

This explains the following axiom that’s reorienting value chains: Whoever generates the demand captures the value.

Consider publishing for example. Substack illuminates many previous market inefficiencies. Writers like Glen Greenwald, Matt Yglesias, and Andrew Sullivan are making up to 10x more than they did previously at legacy institutions, which meant the value they captured didn’t reflect the value they created.

This will happen in nearly every industry: value capture will more precisely reflect value creation, and the best will make 10x+ more than they are now.

Anyone who’s represented by a middleman, if they’re a smart business person, will get a deal that reflects the value they’re creating, or they’ll simply go directly to their fans. Cut out the middlemen; increase profits.


Venture Capital is another interesting example. A couple decades ago, it was harder to get a company off the ground: harder to raise money, harder to quickly test new ideas, harder to reach your customers, and harder to scale something without raising money first.

As a result, founders were more likely to pitch what VCs wanted to hear. As such, the balance of power was on the VC side. Founders marched onto Sand Hill road and pitched the oracle VCs, hat in hand.

Overtime, as it became easier for founders to start companies — and to prove demand even before building anything — the balance of power shifted in favor of founders. VCs moved to SF, and founders no longer begged for money. Instead, VCs begged founders to let them invest.

The courting dynamic inverted. WhatsApp picked Sequoia — not the other way around. VCs were suppliers, and the internet commoditizes suppliers.

To differentiate, VCs "added value" and became "founder friendly”. Those terms came into being to reflect the new power dynamics. As a result, founders just need to focus on their actual customers and investors would follow. Chase customers, and VCs will chase you. “Build something people (i.e customers) want” is obvious today, but was foundational in the late 2000s.

VC further changed with the rise of operator angels. As capital evolved to fit the founder’s needs, so did who represented that capital. It turns out founders would rather have other founders on their cap table than only career investors. And now the capital source is finding better middlemen (ie. other founders and operator angels who founders want on their cap table.)

To summarize: Initially, the constraint was capital. Founders couldn’t build anything without it, so they kowtowed to VCs because VCs were kingmakers. So founders had to beg and take what they could get. Then, thanks to AWS and internet native growth channels that enabled people to build and distribute products, founders gained leverage. After all, they generated the demand.

When the tables turned and founders started calling the shots and picking their investors, they also wanted to pick the archetypes of their investors. Forget the suits; they now wanted other founders. VCs and LPs responded by funding scouts and micro-funds to service this new need. And as the market became more efficient, capital found the most value-additive middlemen. Of course, as the market becomes even more efficient, it may replace middlemen altogether (e.g. venture studios). Whoever generates the demand captures the value.

Music is another fascinating example because it hasn’t yet had a reorientation of value capture, even though it has been upended by the internet. Pre-internet, record labels created stars by giving them radio play. In the era of YouTube and Spotify, now record labels are picking stars instead of creating them — people are already huge before they get signed. And yet, record labels haven’t particularly changed their deal structure — they still give big upfront advances, but they keep a majority of the upside on the backend for themselves. It’s the opposite of how venture capitalists structure deals with founders. What’s fascinating is that artists are starting to fight back. Ben Thompson chronicles how Taylor Swift, even though her masters are owned by someone else, is creating new replicas and ordering her fans to ignore the past version and listen to the future version. That’s how much power the star has over the middlemen; if only they’d choose to exercise it.

Speaking of, let’s consider the NBA. The value chain does not reflect where value is created, namely with the players. Specifically, NBA players don’t have any equity ownership in their teams or the league. They’re paid big salaries, but don’t see the upside of their work, and they often don’t get paid as much as the owners do. Imagine if founders got big salaries but captured only a small percentage of the value they created… You’d disincentivize company creation.

And yet players are the product. They are who the fans come to see. The owners handle all the other stuff the players don’t want to do, but no one goes to a Warriors game to watch Joe Lacob — they go to see Steph Curry. If players teamed up and started a new league, I’m sure fans would switch and pay for it directly. That’s the mindset shift. The fans aren’t there to see the NBA. They’re there to see the players in the NBA. Take out Lebron and 20 other stars and you could create a new NBA overnight. The NBA has created enough cultural capital that maybe it wouldn’t die overnight, but, if forced, it would significantly renegotiate to keep the value creators (the players) happy.

Expect a similar value-chain shake up in every industry moving forward. Middlemen who merely route supply and demand without adding significant value along the way will get squeezed out.

Whoever generates the demand captures the value.

Until next week,