For the past two months, I changed the default search engine on my browser (ironically Chrome) from Google to Bing. I have used Bing almost exclusively for this period, and have two quick conclusions.
1) With regards to core search, the Bing results were perfectly fine. I never struggled to find anything. I never forced myself to redo the search on Google. So I would say Bing is on-par in terms of traditional, core search quality.
2) Where I did struggle was with the non-core search searches (i.e. maps, images, videos, news). Microsoft and Google use slightly different UIs on these non-core searches, and I had no idea how trained I was on the Google UI. Trying to learn the Bing tools and features was quite frustrating, and on those searches – I kept returning to Google. Plus, I didn’t realize how often I transition from one type of search to another (from core to maps, or core to news). This was another point of frustration. Keep in mind, I did not have a problem with Bing’s non-core results, just rather the navigational elements.
At the end of the day, for me, my user “lock-in” is associated not with the quality of Google results, but rather with the understanding of the UI features and levers. More like a traditional software application.Read Full Post | Make a Comment ( 11 so far )
Last night, Google reported financial results for the second quarter of 2010. While revenue growth was up 24% year over year, revenue was fairly flat compared with Q1 of 2010. Moreover, earnings fell short of average street estimates sending Google down $20 per share (4%) in the aftermarket. Based on current estimates (which might change tomorrow), Google currently trades at 18 times the street average for 2010 earnings, and 15.5 times the same number for 2011. These represent price/revenue multiples of 7.5 and 6.5 for 2010 and 2011 respectively. For a long-term tech investor, these valuation multiples seem surprisingly low for a proven market leader. What gives?
Over the past 30-40 years of tech investing, public investors have come to expect the market leaders in each sector to trade at valuation premiums. On average, these market leaders have had respectful PE multiples of over 30X forward 12-month earnings, and price/revenue multiples in the 6-10X range. As examples, Microsoft and Cisco held 30X+ PEs for many, many years. With this as a backdrop, many are surprised that Google, which is relatively young at only 12 years old, is burdened with a PE multiple that is typically associated with the senior-citizens of tech leadership. Google’s forward current PE multiple isn’t remarkably higher than Microsoft (12.75) or Cisco (15).
While there is no exact science for what leads to higher PEs, there are many theories. Some argue that PE’s relate to growth. That said, Google’s growth is much higher than Microsoft and Cisco, and yet it doesn’t have that much higher a multiple. My good friend, Mike Mauboussin of Legg Mason, suggests that higher PEs reflect more concrete competitive advantages. I have always been a huge fan of this theory he calls CAP (which stands for Competitive Advantage Period). It also dovetails nicely with Warren Buffet’s competitive moat theory. However, when I look at Google, I see a company that is well positioned strategically. All attempts at dislodging their leadership have been unsuccessful to date. As such, I don’t think they suffer in this area. One other area typically cited is the more amorphous category of “execution.” I also have a hard time seeing this as the culprit, as Google’s recent execution on Android is pure genius. Moreover, the Google Apps progress is extremely impressive.
So if its not growth, competitive position, or execution, what is the shortcoming that hurts Google’s valuation? Believe it or not, the problem is that their initial business model was “too good.” Before I explain take a look at the included chart. Microsoft was founded in 1975, it went public in 1986, reached $10B in sales in 1997, and fell below 20% growth in year 2000. Google was founded in 1998, went public in 2004, hit $10B in sales in 2006, and fell below 20% growth in 2009. So it took Microsoft 22 years to hit $10B in sales. Google did it in 8 years. Resultantly, Microsoft had growth of greater than 20% for 26 years; Google for only 11.
I would argue the reason for the noted disparity is pricing optimization and pricing power. When Microsoft first established DOS as a market standard, they reaped about $10/PC in royalties. By the heyday of Windows NT, Microsoft was receiving well over $120/PC in the enterprise. Additionally, they layered in Microsoft Office on top of the OS, which took revenue/PC well north of $200. That’s a 20X increase from where they started. Google’s brilliant bid/market based ad product optimized pricing remarkably quickly. As such, Google reached $10B in revenue in about 3X more quickly than Microsoft. Unfortunately, this coin has two sides.
With its ad optimization engine so amazingly efficient, Google has no obvious pricing power against its current installed base. There is simply no way to “double” the amount of spend from each customer, much less a way to take it up 20X. Additionally, they have not yet identified a product that would represent the Google’s version of Microsoft Office in terms of revenue leverage. The Enterprise Apps offering is phenomenal, but the numbers are simply too small relative to search. More importantly, the Entprise App product does not “sit right on top of” the search franchise (as Office was to Windows), limiting the ability to leverage the success of one product into the other.
Of course, there is little reason to weep for Google. As mentioned earlier, they appear to be rocking in many areas. Google mail and calendar are now used by over 2 million unique organizations. Also, the execution of the Andoid team will be talked about for decades to come. And even though they may be limited in their price leverage on core search advertising, they still have that blank wide open home page, that I suspect is at least $1 billion in forgone annual ad revenue.Read Full Post | Make a Comment ( 23 so far )
“It’s funny how fallin feels like flyin,
for a little while…”
On July 1st, Google announced its intention to acquire ITA Software. ITA owns a primarily B2B airfare search and pricing system called QPX. Several of the leading online travel sites, like Orbitz, Kayak, and Bing Travel, use information from QPX to power their airfare search. Many in the industry view this move as a seminal event in Google’s history, as the company makes a decisive step from being a general search engine, into more structured vertical search. Certainly, Google already offers vertical search in Images, Videos, Maps, News, and several other categories. Despite that, ITA feels different. Perhaps the difference is that this is a step into a vertical where many independent incumbents, like Priceline and Expedia, who are material customers of Google, have large established businesses.
There are two reasons mentioned for why Google feels compelled to dive deeper into verticals. The most straightforward explanation is competitive pressure. Following its own acquisition of Farecast, Microsoft has subsequently launched Bing Travel, a much richer travel search product than offered on Google today. The second argument given for the move is that by moving deeper into verticals, and closer to the actual transaction that Google can actual make more money per visit. This argument suggests that CPA (cost-per-action) is a fundamental improvement over Google’s current business model, CPC (cost-per-click). The competition argument seems obvious and accurate. However, it is not at all clear that going deeper in verticals will raise Google’s revenues. In fact, there are several scenarios where they could actually go down.
Let’s first address the easy part – competition. Bing buys Farecast and Google needs to respond. This make sense, but it is not the whole story. If you are searching for a book or an author you go to Amazon, or at the very least you do a search like “Man in Full Amazon” so that you go directly to the page you want on Amazon. The same is true for hotels with TripAdvisor and for restaurants with OpenTable. These sites offer deeper and richer experiences for a vertical searcher precisely because they incorporate deep meta-data, faceted search, transaction connectivity, and typically a form of community or UGC (user generated content). These things simply do not exist in the simple but limited Google user interface that Om Malik affectionately refers to as “10 blue links.” So Google has competition in verticals not just from Microsoft, but also from best of breed vertical sites offering users a richer, deeper experience.
Some have suggested that Google’s move into a deeper vertical experience is more about greed (more money) than fear (competitive) response. The argument voiced by Barclay’s analyst Douglas Anuth and others, is that by moving closer to the transaction, Google can ask for CPA fees, which naturally carry higher margin. Clearly, a single CPA fee will be much higher than a single CPC fee, but you will also have much fewer of them. The variable that links the two is conversion. One can certainly argue that Google can drive higher conversion if they can help drive the customer closer to the actual result they need. This will require a materially better product. Even then, however, there are two key reasons Google may not see higher revenue with deeper vertical integration.
Reason #1: Irrational CPC Pricing on Google Today, “Uber-Optimization”
Some might argue that Google’s current bid-based CPC model results in “optimal” pricing. The argument would be that the market-clearing price settles out at the precisely rational price for each and every keyword pair. A market-place model naturally results in efficient pricing. While this makes logical sense, we all know that there are companies participating in the CPC purchasing game who simply are less sophisticated than others. Moreover, many of these buyers win bids and have huge CPC budgets. The point is that there are plenty of startups, arbitragists, and even large companies “experimenting” with CPC purchasing in an attempt to gain an edge. The winner in this bidding game isn’t the most rational, but simply the one with the highest price. Certainly, over the long run if a company irrationally pays too much for CPC ads, they will eventually go out of business. But the key word here is eventually. For a long period of time, they are paying an “uber-optimized” price for their keywords.
If there are enough of these players in the market, then Google’s CPC prices aren’t economically rational. Rather, they live slightly above that level driven by irrationality and experimentation in the market. If you have a hard time with this theory try typing a search term like “laser treatments” in Google and look through the list of CPC purchasers on the right side of the screen. Would you put money in these companies? Do you have confidence they will be around in ten years? Have you ever heard of them? It gets even better. Many believe that Google uses a low quality rating score on these “middle-men” to force them to pay a higher fee for a single CPC, thus getting an even higher price than previously discussed. That’s right, for certain CPC buyers, Google has a mechanism for extracting an even higher price, even if the buyer is already the high bidder!
As Google moves past its “10 blue links” model and connects directly to airlines, hoteliers, etc, it will be removing the irrational and arguably temporary middle-man from the system. This fleeting but determined participant, very likely has a negative long term ROIC, and Google, riding the brilliance of the CPC model, stands as the beneficiary. With this player out of the system, and with the connections directly to the service provider, the model will naturally trend to a more efficient pricing. You will have fewer larger players, who are all more rational, and all more experienced. As such, you would have to expect more rational, and therefore lower, pricing. Building a better product could actually result in less lead-generation revenue.
Reason #2: Moving from a Marketing Channel to a Transaction Channel
If you have ever sold anything on the Internet, ask yourself the following question. What is the maximum amount you would want to pay for a transaction fee? 5%? 10%? There is data in looking at typical affiliate fee percentages, which can range from say 4-15%. Amazon charges 6-15%. Ebay charges about 11% (with Paypal). Comparison shopping engines make even less. When an etailer assumes they are “always going to pay” for something on every single transaction, they are very sensitive to the % of revenues, as this payment will always reduce their margin. One could assume the general average for all affiliate fees or similar distribution type arrangements is around 10%.
Now, ask someone in your marketing department how much they are willing to pay to “acquire a customer.” While I don’t pretend to support this logic, the Lifetime Value of the Customer (LTV) model depicted herein mesmerizes many marketing managers. Using this simplistic but highly regarded model, many marketers justify “acquiring a customer” not as a percentage of revenue, but as a percentage of life-time value. The key to reaching this Zen state of marketing awareness is to believe that Google is sending you this customer only this one time, but for here ever after this customer is going to come directly to your own site, bypassing Google. This logic supports a much larger denominator, known as LTV. With LTV, ad buyers are easily willing to spend 25-50% of a first purchase in order to “acquire a customer.”
We could talk forever about the LTV formula, and we could argue back and forth about its efficacy, but that would miss the point. Consider the following assertion. People that are buying CPC ads are frequently marketers, and marketers are much more likely to think in terms of LTV. When you enter into a CPA deal it feels very transactional. When you do deep integration it feels very transactional. And, if Google is building a deep vertical site in travel that will pass leads to companies like American Airlines it will feel very transactional. It will be harder and harder to assume that you are “acquiring a customer,” and it will feel more and more like you are paying a distribution fee to a channel. As such, it may turn out that moving deeper into a vertical will puncture the illusion that marketers are “acquiring a customer” from Google, and get them in touch with the fact that they have a permanent CPA “transaction fee” they need to “pay” to Google. The end result is a lower overall rake for Google with the per transaction model.
Could this be wrong? Absolutely. Perhaps conversion rates will triple due to the incredible design, implementation, and ease of use of the Google’s new product, more than offsetting the two points we just mentioned. Or perhaps, Google will have such a powerful place in the travel ecosystem that travel companies will simply be “price-takers.” If this is the case then Google will once again find the exact right way to optimize their business model. It is equally likely, however, that Google’s current business model is highly, highly optimized and tweaking it may have as much risk as upside.Read Full Post | Make a Comment ( 18 so far )
In a recent New York Times article, Kathryn Huberty, a Morgan Stanley analyst was quoted suggesting that Apple’s iPhone is the key catalyst for an important new technology trend. “Applications make the smartphone trend a revolutionary trend – one we haven’t seen in consumer technology for many years.” This argument rings true in that the “after iPhone” smartphone market is dramatically more interesting than the “pre-iPhone” smartphone market. Later, Ms. Huberty made an even bolder statement, “The iPhone is something different. It’s changing our behavior…The game that Apple is playing is to become the Microsoft of the smartphone market.” Or perhaps not.
Many analysts and bloggers have worked hard to position “iPhone vs. Android” as the title fight of the decade in the technology industry. It is an easy comparison to want to make. Both phones use rich microprocessors, are graphical, both have GPS and Wifi. They both run a sophisticated operating system, and they both give you access to thousands and thousands of third party applications. In most practical ways, they seem similar. However, there is one fundamental difference – business model choice.
When Apple launched the iPhone, it was able to secure an unprecedentedly strong business relationship with AT&T. Not only did Apple want control over the user interface, something carriers had been extremely reluctant to cede, it also wanted previously unrealized economics for a handset or OS designer. Apple insisted on upfront revenue dollars as well as a cut of the cellular service stream. AT&T, desperate for a win vs. Verizon, acquiesced. The product was launched to rave reviews from analysts and consumers alike. It really was a brand new market and a brand new product. As noted earlier, we only “thought” we had seen smartphones before the iPhone. This market, as Ms. Huberty notes, looks like one that is Apple’s to lose.
With the iPhone’s massive success, it would be hard in retrospect to challenge the thinking behind Apple’s business model choice. After all, it will always be true that Apple was the company that “cracked open” the famed Walled Garden of carrier-land. They also did it with style, demanding golden economics as it disrupted a previously obstinate industry. And although AT&T may have become “comfortable” with its choices as a result of the iPhone’s success, other carriers suddenly had an “iPhone problem.” Enter Google.
If Apple’s business model is aggressive relative to the carriers, in contrast Google’s seems unrealistically accommodating. You want to control the user interface? No problem. Want access to the code? We’ll make it open source. What kind of economics do we want? Nothing at all. What the hell, we will pay you! That’s right. Google will give the carrier ad splits that result from implementing the Google search box on any Android phone. FBR Capital Markets suggests that Google is taking this idea one step further in its November 24, 2009 report titled Implications of a Potential Share Shift to Android-Based Wireless Devices. “Recent support for Android-based devices appears to be correlated with significant up-front financial incventives paid by Google to both carriuer and handset vendors.” FBR goes on to suggest that these incentives may be as high as $25-50 per device. This is simply an offer that no carrier can refuse, particularly when U.S. carriers are currently in the habit of paying $50-150 per handset sold in subsidies.
While Apple may have opened the proverbial Walled Garden, it is Google, with its aggressive Android offering, that aims to obliterate it. Make no mistake about it; Apple was the pioneer with the amazing revolutionary product. Also, with no iPhone, there is no Android. This is not to say that Android copied iPhone, but rather the impetus to adopt and trust Google’s Android offering was driven by a market dynamic that resulted directly from the iPhone’s success. Without the iPhone, it is possible that most carriers might have opted not to use Google’s OS solely for the reason that letting a powerful company like Google in the front door can be a risky strategic bet.
All of this is now history. The iPhone does exist, and it is wildly popular. There are an estimated 55 million iPhones in use around the world. Despite this remarkable success, history will also show that Apple intentionally chose a business model with plenty of room for disruption underneath its pricing structure. It also chose a single carrier as a partner, which resultantly threatened others. Then Google built a product and a strategy that allayed the carrier’s relative fears. Google gave them what they wanted, and then even gave them money. It could afford to do this because Google aims solely to protect the great business they already have in advertising, not to make money directly from the product (HW or SW in this case). Microsoft Windows, Internet Explorer, and Mozilla’s Firefox represent choke points on the personal computer whereby Google could lose search share, or at least be forced to pay a toll. In mobile, they see a chance to potentially eliminate the toll-takers.
With a business model that allows for much broader distribution and price points that are well beneath the iPhone, Google’s Android won’t compete directly with the iPhone. For the iPhone loyalist, like Stewart Alsop who railed against Android, Android is simply not an option. This price insensitive user demands the very best experience they can possibly have and this is still the iPhone. Users won’t switch in mass from the iPhone to the Android. It’s the other 3.95 billion cell phone users that are highly likely to consider Android a step up from their current feature phone. The Android strategy results in phones at much lower prices with much more diversity which will hit a braoder set of demographics. Apple can and will quintuple its current market share and still have a small portion of the overall cell phone market.
This is why the two products do not compete head to head. With its super aggressive model, Android will be the choice of the masses, and with its sleek design and non-compromising price point, Apple will rule the high end. Many have suggested that Apple is perfectly happy with its high-margin spot at the top of the food chain. They are doing exceptionally well with that position in the personal computer market – in fact, they are currently gaining share at an accelerating pace. So no need to worry about Apple, they are doing just fine (as their stock price suggests). They are just not currently executing a model to become the “Microsoft” of the smartphone market.
Some will argue that the best product will win the market and that Apple will still dominate the smartphone market. The history of the personal computer market is no omen for this thesis. If you think about it, the people that know this better than anyone are the exact Apple loyalists who have been frustrated for years at Apple’s lack of dominance in the PC market. Disruptive business strategies can and have trumped better products. And with no change to the current market, the Android leveraged position in the market could result in staggering unit share gains. This is not to say that the Google Android is better than or as good as the Apple iPhone. The key point is that it does not have to be. It only needs to be dramatically better than the current feature phone. Which it is.
While Apple will be fine as Android gains steam, the amount of shrapnel flying around this new marketplace is immense, so expect innocent bystanders to be compromised. Recognize that as Google’s play here is as much defense as offense, they have less of a need to “make a profit,” at least right out of the gate. This type of attitude always makes for a messy competitor. Also, because of the sheer breadth of the effort in terms of number of handset makers and number of carriers, Android will be marketed extremely aggressively. Lastly, the early application leaders are beginning to believe it’s a two horse race. Currently the iPhone is priority number one. That said, increasingly these application vendors are seeing Android as the primary second platform to support. Others are falling further and further behind.
Also, Android doesn’t appear to be an OS that stops at the smartphone market. Expect much experimentation with a variety of hardware manufactures and almost any and every embedded device market from navigation devices to e-readers to tablets and beyond. Android gives every Korean, Taiwanese, and Chinese manufacture whoever wanted to approach these markets a huge head-start. Additionally, the more of these vendors that build on Android, the more Android will evolve for the better. The number of applications will increase, and the problems will get worked out. Just like Microsoft worked its way from Windows to Windows 3 and eventually to Windows 7, Android will improve with time as well.
With its disruptive and leveraged strategy, it is Google that is attempting to be the Microsoft of the smartphone market. Perhaps ironically, Apple is well positioned to be the “Apple” of the smartphone market.Read Full Post | Make a Comment ( 154 so far )