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This past week, the latest Google (NASDAQ:GOOG) experiment entered pilot mode. Google began seeking out testers in the San Francisco Bay area for a service called Google Shopping Express. The service advertises unlimited same-day delivery. Conquering same day delivery now appears to be the holy grail in the quest to fight off the evil Amazon (NASDAQ:AMZN) empire. The irony is that Amazon already offers same-day delivery in at least 10 major U.S. cities. The service proposed by Google is slightly different, but the point is still the same. Google and its retail partners are playing catch-up to Amazon in attempting to enter this field. The service itself offers a number of questions. Is this an offensive of defensive move by Google? Does it actually benefit the retailers who partner with Google? Finally, from an investment standpoint, can Google actually make money on this service? After answering these questions, you should begin to realize why I believe this service is flawed for all parties involved, except possibly the consumer.

Is Google Playing Offense Or Defense With Shopping Express?

This depends on why Google is offering this service. If they truly have a desire to be a marketplace conduit in a same-day delivery service, then I believe this is altogether a defensive move. It would be defensive in the sense that Google is only entering this space to protect their core search advertising business. A recent study showed that 30% of online shoppers start at the Amazon site versus 13% who start at a search engine such as Google. In only 2 years, this is a complete reversal of shopping behavior on the internet.

You also have the recently released study from eBay (NASDAQ:EBAY) which essentially called into question the value of paying for advertising on Google. It is a fascinating bit of research which essentially validates that a company with strong brand name recognition, such as eBay, generated far less in incremental revenue from Google advertising than previously assumed. To be clear, it is not the results of the study that are all that fascinating. That eBay took the time to do the study and then publish the results for the world to see is what is fascinating. This is a clear shot across the bow of Google by eBay in attempting to devalue the search advertising platform that Google offers.

Google Shopping Express is a defensive move because the Amazon and eBay examples above are proof that established retailers will rely less and less on Google. Thus, Google will receive less and less advertising revenue from these established brands. Enter Google Shopping Express, a way to try to fight back against the retailers who no longer need Google to drive traffic to their sites. The question then becomes, can Google offer a value proposition to the consumer that is robust enough to alter what are becoming established consumer shopping habits online.

Does The Service Benefit Retail Partners?

The landing page for Google Shopping Express highlights a few of the retailers taking place in the pilot program. Two of the featured retailers are Target (NYSE:TGT) and Walgreen (NYSE:WAG). Just using these two retailers as an example, it is difficult to understand what they stand to gain from being a part of this service. Suppose Google is able to design a nifty website that can integrate all participating retailers products. In the case of Target and Walgreen, assume a subscriber to the service is able to view product from both companies. Now assume a subscriber is looking to have a pack of baby diapers ordered and delivered that day. Would you imagine that Target or Walgreen would offer the better price? Let's take a look at a real world example of the pricing below from both retailers websites today:

(click to enlarge)

The same product from Target is significantly less expensive than it is at Walgreen. The consumer always will gravitate to the cheapest option if the product is the same. This illustrates a significant flaw in the reasoning of why retailers would want to be a part of this program. How often would Walgreen be able to compete with Target on price? The answer is probably quite infrequently.

The second glaring flaw in this program comes straight from a blog posting from the Product Management Director of Google Shopping Express. In that posting, the following line stands out as to the lack of logic behind the service:

So hopefully, no more trips across town for simple errands

How often does a person have to go across town for a simple errand in this day and age? The service will not target rural communities or areas of the country that still use a horse and buggy to get around town. The service, to have a chance of success, will be launched in major urban areas. The last time I was in New York or San Francisco there seemed to be a drug store on every corner. Any medium sized city I have ever been in had a store that would provide the goods needed from a "simple errand" within a 5 minute car ride of residential areas. Is it convenient that someone might be able to save 5, 10, or 20 minutes not having to run a simple errand? Sure, I will not argue that point. However, simple errands often end up being those where you realize you need ketchup, toilet paper, or medicine. You can't plan ahead for those oops moments where you need something immediately.

You also have the opportunity cost to retailers. It is common knowledge that the concept of impulse buying does exist. Why do you find candy, gum\ and magazines at the checkout counter at every retailer you visit? Because impulse buying drives profits for bricks and mortar retailers. There are even studies, such as this one that prove impulse buying is more prevalent in a store than online. How badly does a retailer want to chase additional revenue at the cost of keeping that consumer out of their store? It becomes a zero sum game for retailers if revenues grow, but profitability stays the same or even declines due to a pricing war.

Finally, does this type of program not simply further erode brand awareness and profitability for participating retailers? Let's go back to the above example of Target and Walgreen. It would be foolish for Walgreen to sacrifice profitability to try to compete with Target on pricing. The example above could be extrapolated further. If you have a company such as Target in the program, other retailers would simply not be able to compete on price. On the other hand, assume Google is able to make the shopping website company agnostic. That is to say the consumer does not know if the product they are purchasing comes from Target or Walgreen. In this case, Walgreen could decide to compete with Target on price by sacrificing overall profitability on an item. Even this example is fraught with pitfalls for the retailer. If the shopping experience is retailer agnostic, the only winner is the consumer. The brand loyalty and value for all of the retailers is degraded if the consumer has no interaction with them. I am all for the consumer being a winner, but from an investment standpoint, this example serves to illustrate why the retailers involved could end up being the losers.

Profit Potential For Google From Same-Day Delivery

If you can assume the retailers are willing to take the risks noted above, how valuable or profitable could this service be to Google?

First we need to understand what Google will charge for the service. There is no confirmed pricing, but it is probably safe to assume they will be below the $79 that Amazon charges for its Prime two day shipping service. Speculation is that the service might start at $64-69 annually. For the purpose of developing a financial model, we will assume it is $69. Next we need to determine how many potential subscribers might sign up for the service, if it makes it beyond the pilot stage. The latest research suggests Amazon Prime membership might be around 10M members currently. So we will assume that Google Shopping Express can grow to that number and eventually surpass it. The biggest assumption then becomes at what cost can Google fulfill an order. Consider that Amazon currently charges Prime members $3.99 to have an overnight delivery instead of a free two day delivery. Let's go totally out on a limb and assume the cost to Google is only $1.50 to fulfill an order. No, I am not assuming they can teleport the products with their Google Glasses. Based on the above assumptions the following table contains the key data to model the potential profit for Google:

(click to enlarge)

Based on the above table we can then extrapolate what the earnings potential is at various subscriber levels shown in the following table:

(click to enlarge)

The financial takeaway from this entire analysis is straightforward. If Google were able to somehow deliver an item with same day delivery at a cost of only $1.50, and had 40M subscribers, the company could generate an additional $1.79 in EPS before taxes. This equates to about 4% of the total consensus EPS estimates for Google in 2013.

Summarizing Google Shopping Express

Unlike Google Fiber, Google Shopping Express is a service that does not carry a significant amount of financial risk if it were to be a flop. However, you have to wonder if Google actually cares if they make money with this service. I believe the analysis above shows it is highly unlikely they could make a material profit from it. Further, I think the retailers who partner with Google as part of the service take on financial and brand risk in the chase for additional revenue.

This service appears to be a clear attempt from Google to stop Amazon and others from further devaluing the Google search business. It is a blatant attempt to offer an alternative starting point when a consumer begins their retail adventure online. With 30% of online shoppers already starting at Amazon, Google has a tough road ahead of it. With 95% of their profits directly tied to search, it is easy to see why Google appears to be grasping at straws to defend this business at all costs.

Source: Google Shopping Express: Flawed Concept For Google And Retailers