A lot of people are equating this to 1999, and there's real parallels here. Ordinary people, in my view, will be the ones left holding the bag. I think there's going to be an AI/data center bailout from Trump, who's bet the entire economy on AI's or the valuations of AI to continue to be out over their skis.
Today we talk about the data center building boom, Apple's new subscription model, and how to position yourself for a promotion. Question number one comes from a listener who emailed us: "Hi Scott, I'm an ex-UK army engineer officer working on grid upgrades in the Scottish Highlands. Your No Mercy No Malice episode 1999.ai has led me to believe that the push on data center construction is ill-advised and will end up with data center developers holding the crying baby with incomplete sites and sunk cost. There's also the question of realistic capacity in the grid and the demand from new building housing in other sectors. Is the model of speculative build of data centers for hyperscalers destined to fall down?"
Some data: most announced data centers were never real. To build a data center, a developer applies to plug into the power grid, and operators get five to ten times more applications than real buildings because they file a whole pile to hedge. Most have no financing, no power deal, and no equipment order. And some most planned data centers are press releases. Bloomberg expects a third to half of all US data centers planned for 2026 to be delayed or cancelled.
Why people seem to the latest scare around AI is the debt. Wall Street's mood has flipped fast, and Bank of America's investor survey: 45% now call the AI bubble the biggest risk, up from 28% a month earlier. The buildout runs on borrowed money right now. One estimate puts the giants' hidden debt at $1.7 trillion. That's up eightfold in four years. The scary part is what's not in plain sight here, and that is $800-plus billion is pushed off the books into shell companies. So it's hard to see who's going to eat the losses. Plus, this debt is backed by chips that can lose value overnight if a better one emerges.
A lot of people are equating this to 1999, and there's real parallels here. Ordinary people, in my view, will be the ones left holding the bag. I think there's going to be an AI/data center bailout from Trump, who's bet the entire economy on AI's or the valuations of AI to continue to be out over their skis. In many states, utilities are guaranteed a profit for building power plants. So if the demand never shows, it lands on everyone's power bill. The financing is circular. Nvidia sells the chips and lends its customers the money to buy them. And so the same dollars keep flowing in between a handful of companies, making demand look bigger, artificially bigger than it is.
The end here or the slowdown isn't likely one dramatic bang. It's kind of a slow rolling thud, similar to 2000 or to 2002, where the weakest, most borrowed players fall first while big tech survives. So this listener, you're right about the crying baby and who'll end up holding sort of the overleveraged developers and the ratepayers, not the hyperscalers.
But my understanding is you're working on grid upgrades in the Scottish Highlands. I think it's interesting to be in the center here in a specter. I would argue, as it relates to your job, I still think the demand is going to be pretty substantial and that your skills are going to be in pretty high demand for a while. In other words, the technology and I do think the data centers will survive. I just don't know what the valuations will be or who pays off the debt to finance these things. But as it relates to what you're doing, I think you're in a pretty good spot right now.
One working in the Scottish Highlands. I mean, I have an ability to romanticize Scotland because I think it's the most beautiful place in the world. So to be there, and I don't know if you're working outdoors or probably not. I don't know to have any skills around adjacent to data centers right now is a pretty good wrap probably for a few years. I just don't think these things are going to... I don't think we're going to stop building data centers. I just wonder if the people financing this type of growth are going to scale back or their debt is going to come under pressure. But brother, to be working in the Highlands and have skills around what is at the center of AI, and that is a data center buildout, I still think there's going to be enough demand to justify the centers that do get approved, if you will.
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Question number two comes from Jacob. "Hi Scott, what do you think about Apple's move to a subscription-based model? To me, the subscription model not only means more reliable revenue for the company, but it is also stickier. When consumers get on the plan, they'll likely be content to keep receiving new iPhones regardless of the fact that the only substantial upgrade year-over-year is a better camera. Apple knows they are done innovating in that space and they want to lock in customers. Now I'm curious about your thoughts."
Yeah, I think we're in violent agreement on this one. So on July 28th, Apple launched Apple Upgrade in the US. The program will let customers pay a monthly fee for an Apple product, then upgrade to the newest model, return the device, or buy it outright when the lease ends. Leases start at $18 a month for an iPhone. This is likely a reaction to a slowing upgrade cycle. The average global smartphone replacement cycle is expected to stretch to four years in 2026, up from three and a half years in 2025. And some the improvements have become incremental. And I think people have decided they don't need the latest and greatest right when it comes out.
Apple's subscription business is working. Apple's services business, which includes subscriptions, the App Store, iCloud, and Apple Care, brought in over $30 billion last quarter. We think of Apple as being a transactional company, but at $30 billion a quarter, $120 billion a year, it's got to be one of the five or ten largest subscription companies in the world. That's up 12%. Apple has now more than 1.5 billion paid subscriptions across its platforms. Services carry an estimated 77% gross margin versus 39% for hardware, meaning a service dollar is roughly twice as profitable as the iPhone dollar. The services segment lifted Apple's overall gross margins to 49%. And some Apple is converting an unpredictable four-figure purchase into a predictable monthly payment that keeps customers inside its ecosystem.
Like so, let's bring this back to me. I started a company called Profit Brand Strategy my second year in business school, where basically I was renting my brain to old white guys who were CEOs and CMOs and helping them make decisions. And I would charge Whirlpool half a million dollars to do their internet strategy, or Levi Strauss & Company, you know, a million bucks over two years to figure out their direct-to-consumer strategy, including owned and operated stores. And about halfway through the engagement, most of my effort and brain power would be focused on inventing new problems that only me and my team could answer. And I sold Profit when it was doing $10 million in revenue for $28 million, or 2.8 times revenues.
I essentially started the equivalent of Profit again when I was teaching at business school, when in 2009 that was L2, where we collect data. But instead of a transactional model, I wanted, quite frankly, I wanted a larger exit. And I read this amazing study from Deloitte saying these are where the irrational multiples, the features that a company that's able to garner an irrational multiple have in common: one, they own a niche; two, they're international; three, they have defensible IP; and four, they have recurring revenues. And that's why software companies, when you have recurring revenues, recurring revenue is exploiting a flaw in the species, right?
So I sign up for Equinox at $250 a month. And I, well, I work out three, four times a week, three times a week, 12 divided into 20 bucks a workout. Okay. I'm never in Soho. I work out there two or three times a year. So I am paying $1,000 a workout. If they charged me $1,000 every time I walked into Equinox, regardless of how hot the people are there and how convenient it is, how nice an environment is to work out, I would not pay $1,000. But because we have a problem understanding how fast time is going to go as a species, we're willing to sign up for something, what, X for a month, that's not a lot, and I'm going, I'll use it at least this much.
In addition, the organization itself can better plan its capex because it knows what its incoming revenues are going to be. So subscription model is stickier. It also forces you to focus more of your revenues not on getting more people into the store, but on the customer relationship, on renewal. So you're instead of investing more money and getting more people into the store, you're investing more money on the relationship itself and how to improve it, which typically creates kind of a better product, if you will. So on average, retailers trade at one to three times revenues, and recurring revenue companies trade at six to eight times revenues.
So cut to, I also sold L2 when I was doing about, oh, I was doing about $20 million in revenues, and I sold it for $160 million, or eight times revenues. So recurring revenue, the, you know, word is out that recurring revenue works. There's probably been an overinvestment in subscription revenues. And it's getting harder and harder because people benchmark against Netflix, which gives you a billion dollars in content for every dollar a month you spend. So as is the reason why it's so hard to build a subscription Substack offering.
Anyways, Apple has been great at this, and they have said, okay, and I'm not exaggerating, I suggested this to Apple maybe three years ago. I said, okay, pretty easy to identify amongst the billion people that have iOS, find the 50 million super users, myself included, that want the latest, greatest all the time, fairly price insensitive, and just say, "We're going to give you every new product 30 days before anybody else. We're going to charge you 100, 200, 300 bucks a month, and the market's just going to love it. Absolutely love it."
And the first thing I ask when I'm talking to a board is how do you figure out a way to move some of your business to subscription revenue? It doesn't have to be all subscription revenue, but if you launch a subscription revenue component of your business and it's growing faster than the core business, the market will start to reward you with multiple expansions. So it'll say, okay, recurring revenues eight times, transactional revenue is two times, but if the recurring revenue part of your business is growing faster than the transactional revenue, your overall enterprise value will start to expand.
In addition, it's just you start investing more in the customer relationship. I just presented to the CEO and the senior management team of Mercedes-Benz, and they asked me, you know, what would you do if you were us? I said, simple. I like Mercedes. They should be able to identify... The best car I've ever owned is a Mercedes truck. When I had kids, I bought, I think it was a GL. It drives like a sports car, but you can have dogs and kids in it. Just an outstanding car. It feels good. It's aspirational without being flashy. Anyways, love the car.
And I realized, let me do my land acknowledgement. I realize most people are not privileged enough to have a Mercedes. But at some point, a car company just needs to take me off the table and just say, James Purse or Buck Mason or what's another brand I like, or Rag & Bone. Scott, you're part of the Boneheads, and we're just going to send you the clothes you want, subscription service. We know you better than you know you. AB InBev, I love beer. There's certain Scott, we're taking you off the table and we're going to send you beer. We understand your calendar wherever you are of your favorite brands, and we're going to occasionally give you access to some sort of cool event that you know because we sponsor every world-class sporting event. There's just so much opportunity for subscription where you take the people off the table.
Why? Because what does subscription do? It alleviates one of the, or it directly attacks one of the greatest myths in business, and that is choice is a feature. No, it's not. And it's a bug. People don't want more choice. They want to be more confident in the choices presented. And subscription says, "Here's a brand." And then a thin layer of AI innovation that says, "We know what you want before you." When I go to a restaurant, I don't order. I ask my son or my partner to order for me. I don't want choice.
One of the things I love about L'Ambroisie, this genius restaurant, that they basically, there's no choice. You get steak, you get French fries, and then I think you get profiteroles. Boom. I don't have to think about it. And subscription revenue sort of does that for you, if you will. And it says, okay, you're done. You don't have to pick anything. You've signed up, you've paid, and it reduces the calorie expenditure around decisions.
Apple's move into subscription has created, I think, a massive amount of shareholder value. Apple right now, the bottom line, it's valued as if it's a growth company, and it's the, I think, the topline one of the largest companies in the world, maybe with the exception of Walmart and a couple others, because it's growing its subscription revenue faster than its core business. Also, it's, I think, it just posted 16% growth on the iPhone, which is staggering. But a decent question, where does this all reverse engineer to? Apple converting unpredictable transactions into predictable subscription revenue is a gangster move. It's only getting started.
I still haven't gotten a subscription plan from Apple. I'm Apple, take me, I'm yours. Do what you will with me. Take my money. Sign me up for a monthly program that gives me some sort of self-expressive benefit or access to new programs or figuring out that I lose my AirPods every two months, so they're going to replace them every three months, whatever it is, right? And I think this is, I think they're just getting started, if you will.
And also, just from a personal standpoint, if you're thinking about a business, ask yourself constantly, what can we do to escape the transactional business model hell and move into a recurring revenue model? If you're a company that sells bikes, is there a bike club where they can, they don't, you know, whenever they want, when they're in town, we'll deliver a brand new Trek bike to you and we'll invite you on cool bike tours maybe even, and we'll always maintain your bikes. Granted, that's going after a wealthy class, but I think there's a lot of people out there. If a chain of bicycle stores can just show that their recurring revenue is growing faster than their transactional revenue, it takes the multiple on that business up two or three. And then they get focused on the consumer, you know, relationship, if you will.
So I'm a norm. I've been preaching, I've been preaching subscription, the move to subscription revenues for a decade now. And probably the gangster move that doesn't get enough credit because Adobe used to sell something called Director's Cutter, a $2,500 software in the box. And then they said, "Nope, we're going to $25 a month." Their stock got cut in half, and now it's up like 40x because they were sort of the original gangsters here of moving to a subscription model.
So Apple, who I think is arguably strategically one of the smartest companies in the history of business, who's not engaging in the AI capex wars right now. Apple, they're like, "No, we'll just hang back and then we'll monetize and let everyone else spend hundreds of billions or trillions of dollars." Similar to what they did with search, they said, "You guys battle it out and then we'll extract a $20 billion licensing payment such that Alphabet can have Google be the default for the billion wealthiest people on the planet." Pulling the plug on the car. Good CEOs not only decide what to do, but what not to do. Think about all the posting Tim Cook has received for not developing, you know, not launching new products. Well, actually, they have Apple Music, Apple TV Plus, and it all feeds into this ecosystem of subscription.
Anyways, Apple's done a great job. What's the lesson to take away from here? Always ask yourself in business, what part of our business could we move to recurring revenue? We'll be right back after a quick break.
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Welcome back. Question number three comes from a listener who texted us. "Hi Prof G, I have a career question. I recently stepped into a general manager role. I've been with my current company for about a year after being recruited by a leader who believes in developing high-potential talent. That leader is now being considered for a VP role, which could create an opportunity for me to step into his position. Given that I'm still relatively new to the organization, how would you think about balancing ambition with patience? More specifically, how do you position yourself as a credible successor while staying focused on helping your leader succeed and earning the trust of the broader organization?"
That's a big question. Look, the adage is true. If you want to be promoted, just kind of start doing that job. And that is demonstrate every day that you're ready for that job. You know, the basics, try and be a good team member, try and highlight and credit other people. But I don't think there's anything wrong with sitting down with the HR manager, the person or your boss, and saying, "Look, I think I'm ready for that job. I hope you'll consider me when you're thinking about the next person or the person that's going to fill that role." And then to the extent you can start kind of fulfilling that role, start, you know, the best way to get a job is to do the job. But I think transparency and if you get passed over for it, you know, be honest. Yeah, I'm disappointed, but I understand you have to make these decisions.
There is something to the power of patience. The American corporation is probably the greatest economic elevator in history. And but the thing about a corporation is you get rich slowly. And by the way, it's just awesome to get rich. So that's not bad. But one of the things I can guarantee you in a corporation is a series of injustices. There will be people get promoted over you that you believe are less talented. You will have things happen in the company that make no sense that just come from a directive from someone you haven't even met before.
But if you're patient and mature enough to kind of handle these small injustices and be patient and a good citizen over time, if you're good and a good colleague and a good team member, things work out. I didn't have that patience. I was at Morgan Stanley and it just bothered me if I perceived people senior to me were not as intelligent as me. And the reality is they're probably more intelligent. They're just more mature and I just didn't have the patience or the maturity. So keep in mind that you're going to have injustices, but over the medium and the long haul, most organizations with good people reward competence and patience and ambition.
So yeah, there's a fine line between patience and ambition, but I would be transparent with your direct boss and the head of HR or the manager who's making this decision. Say, I think I'm ready. And just start doing the job or doing components of the job that demonstrate that you're ready for it. And there's nothing wrong with being ambitious as long as it doesn't come at the cost of supporting your colleagues and talking them up and giving them credit where it's due. And if you don't get it, be as gracious as possible. Congratulations to the person that did get it and ask how you can be helpful. And quite frankly, just do what I didn't do, and that is be an adult and just act more mature.
That's all for this episode. If you'd like to submit a question, please email a voice recording to officehours.com. Again, that's
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