Author’s Note: This piece has generated so much confusion; I am adding this section to summarize the thesis. The focus of this piece is not that Internet destroys all value, but rather that it destroys taxable revenue value in the SHORT-TERM, for those not creating the companies destroying the value. For government, that is a challenge.
If a call from Lagos to Boston is $20. And using Skype, you can make that call for free. Ok, I give you $2 since you have to pay MTN for broadband access. Simply, $18 has been (effectively) destroyed and Nigeria cannot recover that. While Skype can make $1 through adverts while you are there, Internet has destroyed at least $17. Consumers enjoy, but govt and non-digital firms will struggle. This applies across sectors. Internet will destroy massive value as it permeates across industrial sectors. That value is not transferred to the firms destroying them. Skype does not get the whole $17 destroyed from MTN. My point here is that Nigerian government has lost the capacity to tax that $17. In the short-term, it is a problem and that is what I am trying to pass across.
This does not mean that customers have not benefited. Please note that it is possible the savings of $17 by the customers can create $30 in future. Sure, but that is FUTURE; in the short-term, government has to deal with loss of that tax Naira. That is the future. I am focusing on the short-term.
Case Study I: NITDA gets 1% of all profits from Telcos. MTN has been the most reliable to NITDA as it makes profit. But MTN declared loss last year owing to the huge fine it paid. Others like Etisalat (9Mobile), Glo, and Airtel rarely pay or pay very little, because they rarely make much. For NITDA, in the short-term, it has to look for other ways to fund its activities. Had Airtel, ET and Glo made money, NITDA would be fine. Sure, customers enjoyed their Skype and WhatsApp, but the government agency gets its zero revenue.
Case Study II: In U.S., as Amazon.com expands its e-commerce empire, many U.S. cities are seeing the devastating impacts on their real estate taxes as physical stores close. With the real estate taxes gone, some cities are closing libraries, schools etc because they do not have the funds to run them. This supports my notion: those cities did not anticipate what Amazon’s business could have on their tax revenues. This does not mean they are not benefiting from the cheap books they can buy on Amazon. They could be happy as consumers, but for the local governments, there is no money in the bank.
This does not mean that this is all bad, in general. It is creative destruction. I just want us to have a conversation on this from the taxation angle. Government cannot afford to wake up and see empty treasury because banks, telcos etc have seen the erosion of value while the ones destroying them are not compensating for same. Now, read the piece…
Internet is one of the greatest technologies ever invented. It reduces friction in the business processes, enabling a better inter-relationship among nations, firms and citizens. From the private sector to the public sector, Internet has radically changed our world. Many industries are re-structured as a result of new business processes which Internet is enabling.
But behind all these exciting things about the Internet, Internet will destroy value in Africa, even though it will create value in some areas, over time. In the short time, Internet economy will cause challenges to most African economies as their companies experience erosion of value and associated tax receipts.
It will be all well, because the net impact of Internet, will be positive. The citizens will benefits but companies and nations will have to adjust in order to also benefit. Over the long-term everyone will benefit, but in the short-term, there will be severe challenges.
Africa does not create many technologies, which means the value created, at the share capital side, will not benefit us. Of course, we will benefit as consumers. However, our traditional companies will struggle, because their values will be destroyed. If we do not build enough competitive digital companies to compensate, very fast, we may be in real problems.
The Internet Value Destruction
Internet creates value but Internet also destroys value. For all the money Amazon.com has made for its shareholders, many bookshops are gone. For all the simplified lifestyles Google has made possible for all of us, many directory companies have gone bankrupt. That is a good thing, as the users or consumers are benefiting. But that does not mean that governments, especially those without these big companies in their domains, will not struggle. Those governments will lose tax receipts, over time. The following explains how Internet destroys value
- Diminishing Abundance: Internet is a global village. It brings the constructs of abundance. Simply, it commoditizes everything within it. Before Internet, this blog and New York Times have equal rights. When a material is posted on the Internet, that material is available globally. This means that Internet offers abundance in anything which can be available online. The implication is that those that make money through controlled scarcity of goods and services will struggle. (Think regional newspapers.) Also, because of the global pool, the challenge to be the best to compete becomes critical. A Lagos graphics designer does not have any special advantage compared to a man in Pakistan who can offer the same service via UpWork. What happens is that competition heats up, globally, and everyone has to reduce price. When that happens, the global regions with the best talent win. For the Nigerian case, if the job goes to the guy in Pakistan, Nigerian government has lost the tax associated with that revenue. The risk for Nigeria is huge, if it cannot produce enough people that can bring the jobs to Nigeria, to avoid net negative in this cross-border commerce which Internet enables.
- Aggregation Construct: Under the aggregation construct, the companies that control the value are not usually the ones that created them. Google News and Facebook control news distribution in Nigeria than Guardian, ThisDay and others. Because the MNCs tech firms “own” the audience and customers, the advertises focus on them, hoping to reach the readers through them. Just like that, the news creators have been systematically sidelined as they earn lesser and lesser from their works. But the aggregators like Facebook and Google smile to the bank. The reason why this happens is because of the abundance which Internet makes possible. Everyone has access to more users but that does not correlate to more revenue because the money goes to people that can help simplify the experiences to the users who will not prefer to be visiting all the news site to get any information they want. They go to Google and search and then Google takes them to the website in Nigeria with the information. Advertisers understand the value created is now with Google which simplifies that process. Google does not pay tax to Nigeria (sure the small Google Nigeria may do, but get the idea, we are talking of real tax here), but it does depress earnings for Nigerian companies. The news production is now commoditized. This affects the total tax government can collect from these companies.
- Marginal cost: In a perfect market, the marginal cost of a digital product is zero. This means the price of a digital product tends to zero: welcome freemium and ad-supported business. However, only firms with network effects dominate, making it hard for Nigerian government to benefit, via tax, as we do not have those companies.
In this piece, I explain why it is very hard to monetize digital products in Nigeria and indeed Africa. The core reason is that in a perfect market, the marginal cost of producing digital product is zero. This implies that its pricing will inevitably go to zero. This is the heart of the freemium model where you get many things free, which is possible because of the aggregation construct, where companies provide those digital products and then create an ecosystem to sell adverts. They benefit more than the suppliers by providing the platforms. As noted in the plot, great companies deliver the $0 marginal price even at high value, making it challenging for anyone that carries a non-zero marginal cost to compete, exacerbated if the product is even not top-grade.
I will use four companies in four different sectors to explain how this new digital economy will erode and destroy value in Nigeria, and also how Nigerian government will lose tax receipts. This is not really all bad, we just have to understand the short-term challenges and work to mitigate them.
- MTN (Telecommunication): MTN is a leading telecommunication company in Nigeria which sells voice telephony and broadband services to the large spectrum of the Nigerian market. MTN will lose value through the OTT (over the top) services like Skype, WhatsApp and WeChat. These are solutions that ride on telecom infrastructure with only a small part of that revenue going to the telecom firms. Most of the value is destroyed, the OTT firms do not absorb or get most of the value. For example, without Skype, one can make a minutes-long call from Nigeria to New York via MTN service for $20. That money is paid to MTN which pays the Nigerian government tax, accordingly. Government benefits. However, with Skype, the money that goes to MTN may be $2 (the person still needs MTN service to be online to use Skype). The $18 is totally destroyed as Skype has not converted it to itself. That is how Internet destroys value. It has caused Nigerian government to lose tax on the $18 even though Skype did not get that money. Skype, owned by Microsoft does sell adverts but that call could not have generated $18 for Microsoft via ads (it is possible it will be less than $1)
- P&G (Consumer Packaged Groups): P&G does many things to get its products to our homes in Nigeria. It invests in R&D to engineer the products. After that, it puts money in branding and advertisement. Then, it works with supermarkets/shops/etc to help stock the items as part of its distribution and retailing. Value is created along the line for Nigerian government. Tax is paid and money is made. But imagine a situation where say Konga can import one of the products (say razor or shaving stick) from another country and sell it directly to the Nigerian people. The value especially at the R&D will be destroyed because Internet has made it possible to use another country, entirely, and still sell directly to Nigerians, without distributors. A good example is the Dollar Shave Club in U.S. which used Internet to deliver a service which is far cheaper to what P&G Gillette give to men on shaving. Dollar Shave Club is far cheaper and takes away most of the perceived value P&G thinks it creates on shaving products. Before Internet, Konga can still import say shaving stick, but the ease of selling that via online will push pressure on what P&G can command with its expensive high-value product. The e-commerce company and cloud computing which makes it possible provide disintermediation which erodes value for P&G and which ends up hurting Nigeria with the traditional value chain cannibalized. The new one created will not create as much tax value.
- Wema Bank (Banking): Wema Bank runs treasury business which helps it do many things including money transfer. It earns huge amount of money in the process and pays tax on the fees to the Nigerian government. But with fintechs like Paystack and Flutterwave, value will be destroyed on the whole remittance/money transfer sector. These startups will do the transfer more affordably thereby destroying the value for Wema Bank, as trying to match them will result to lower fees from Wema Bank. This is not really a bad thing for the user, but for government, it is not a smiling matter, because the low-cost fees will mean low tax Naira.
- Guardian (Media/Publishing): Guardian sells advertising to the Nigerian suppliers, earning good revenue. Today, some of those ads are moving online. While Guardian will continue to compete online, the bulk of the ad Naira is going to the aggregators like Facebook and Google. Guardian online is largely commoditized, as it has to compete with this blog for revenue from Google Adsense which is runs. For Google to be in the same network with this blog is a bad thing. Traditionally, it ought to have the capacity to sell all its available ad spaces. But this is what Internet does well – it respects no one. The point is that Google ad revenue will drop and the Nigerian government will have less revenue to tax.
Nigeria is not paying attention to the potential risks of value destruction to the economy which Internet will bring to the nation. We will continue to see the erosion of tax Naira as more industries are disrupted. The telcos are first, but our banks are not immune. If the banks face this problem and fail to compete, the tax Naira will go as more value will be destroyed.. The challenge is that value is destroyed, and our local digital companies do not actually drive the destroying process – most times, foreign firms do and get the value. I project that Internet will erode more than 17% of Nigeria’s total tax revenue over the next decade. This does not mean that the absolute tax revenue will drop, rather, some sectors where government makes money, via tax, will earn less. If the telcos earn less because of OTT, they will pay lesser tax. Period. But government can still get more artisans and farmers to pay tax (I want to make that clear – my prediction is not the absolute tax which can be compensated if more people join the tax paying base. I am focusing on taxes from those paying tax right now. While those paying now can drop, proportional to growth, the total absolute tax could be higher because of bringing more informal sector participants into formal sector).
Our digital companies are supposed to help us cushion the impact from this Internet-enabled value destruction. Yes, but they will need to grow and blossom first. I will explain how they can do this.
What Nigeria Can Do
Simply, Nigeria has to pay attention to its capacity to build these companies of the future. The efforts by the Bank of Industry to fund largely asset-driven companies must be revisited to include digital businesses. There is no apparatus for most DFIs (development finance institutions) like Bank of Industry and Bank of Agriculture in Nigeria to support digital companies. Government could even do better: offer free tax to Venture Capital firms for 10 years to enable them come and help us build the businesses of the future.
It is very hard to setup a technology startup, in Africa. One reason is the dearth of investors with capacities to make visions become realities. Across most African cities, technology-enabled entrepreneurs continue to struggle, without capital to scale. They look for investors, they rarely find them.
It is well established that some of the richest men in Africa did not make money through technology. The implication is that most do not understand that sector. So, they are cautious to put money in areas they do not have good domain expertise. You do not blame them – they cannot play chess games with their resources.
Nigerian moment is now to plan because Internet will redesign our economy.
Update: There is a brilliant suggestion in LinkedIn on what Nigeria can do. I am adding same below with the full comment.
Governments use taxes to scale up social amenities – corruption aside, that’s what taxes do for us. With declining oil revenues and lower than expected revenue e.g. from telcos courtesy internet bases innovations Governments will fail to keep up and the masses will suffer poor roads, intensified power outages, poorer healthcare and more. I postulate that the value the internet based innovations give us may be ripped away via declining amenities. Hence Government has to wake up to this reality – a forward looking cabinet should have a committee working on this for the sake of the people. What good is lower call costs when higher transportation and diesel for gensets wipe it away? ndubuisi ekekwe is talking solutions and here are my thoughts in addition to his.
1. Widen the tax bracket – all should contribute for the common good.
2. Remove/lower any tax holiday in industries that don’t fit that core national agenda and where the benefits don’t trickle down to the masses.
3. Shore up the FIRS – go digital, hire smart graduates/poach from the private sector, train them to death, develop a tax strategy and flog the process into efficacy levels never seen before.
4. Offer tax amnesty so arrears are paid and non conformer are on the books.
5. Start a tech revolution in our education system so in the medium to long term our own companies will reap maximum value in Nigeria.
6. Woo big tech companies to set up in country so they pay tax here (hard I know but worth trying after all we have the clout)
7. Fund collaboration incubators to facilitate birth & growth of big Naija tech firms who will offer alternatives (Made in Naija apps) & who will pay taxes here. Enough before I go off point. We just need to redesign how things work to win as a country.
Internet provides many benefits but we must not lose the sight that Internet will destroy value in the short-term in Nigeria, before it creates it. Government needs to model these challenges and ensure that we have the capacity to overcome them. Investing to be creators of the future will be strategic for Nigeria. Our digital economy must have local content and participation for us to benefit from what Internet promises. If not, Nigeria will experience the most consequential moments in its history with decreasing crude oil revenue and erosion of tax base. That is called double whammy.
image credit: Guardian