Thursday, November 23, 2006

Or is it Google $100?

Google (GOOG) $508

Worried lest our last post on the topic (Google $1,000) might become a Blodget-style self-fulfilling prophecy, here is the other side of the argument. Succinctly Google is not Microsoft (MSFT).

Microsoft makes all of its money from its operating system and office tools (actually over 100% since its entertainment biz is not yet profitable). These both benefit from the celebrated network effect: for every product sold all existing customers benefit - the more Windows PCs there are, the more programs will be developed for it.

Google makes all of its money from search related advertising (actually over 100% since it gives away lots of software, including the hosting of this blog, in the hope of revenues to come.) But search is not a beneficiary of the network effect and neither are the advertising programs Google inserts. Your search is not easier because other people have searched before you. The amount advertisers pay per keyword is, if anything, higher because of Google's dominance. The service is used because Google built a better mousetrap. But another, better algorithm is just around the corner. Ask.com (IACI) could be to Google as Google was to Yahoo (YHOO), for example. And as Yahoo was to AOL (TWX). Google has not developed sticky applications or given up so much margin that it has economies of scale. The reverse is true. Google's margins are so high, it is easy to see how smaller rivals could come in to its markets. And we would all switch again. Why wouldn't we?

Current search market shares are roughly as follows:

Google........44%
Yahoo.........29%
Microsoft...13%
AOL .............6%
Ask...............5%

Were Google to switch places with Microsoft in these rankings its revenues would fall by at least two-thirds, to c.$3 billion and its earnings per share to, say, $3. Even with the market growth forecast in our last piece the stock would find it hard to go north of $100 for some years to come.

Disclaimer: We have a position in IACI.

2 comments:

Super Saver said...

Good point, counterpoint on Google. At this point, I think $1000 is more likely to occur first. Whether Google continues to go up or decline to $100 will depend on whether they continue to innovate the current business model or create new ones.

My assessment is that Microsoft will not be a major player in the future. Bill Gates has basically thrown in towel and decided to focus on philanthropic activities. MSFT is perfectly organized around it's business model of operating systems. Perfect example of a candidate for being disrupted as described in the Innovator's Dilemma.

Disclosure: I own shares of GOOG and leap options of MSFT (just in case MSFT has one last rally:-)

Anonymous said...

StockReply writes: "Your search is not easier because other people have searched before you"

Are you kidding? Have you ever heard of PageRank? The reason that Google wiped the floor with Altavista, and became dominant, is precisely because your search result has been auto ranked by previous searches.

Try googling it !