How Google Slips To $100 a Share - And Stays There 7 comments
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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 many blogs, 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 $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.
GOOG 2-yr chart:
Disclaimer: We have a position in IACI.
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This article has 7 comments:
Where am I going with this? You said:
"Google's margins are so high, it is easy to see how smaller rivals could come in to its markets."
Google has a competitive advantage (the reason it has high margins), a significant one: technology that was developed by the world's best engineers over several years. Also, their brand provides a competitive advantage, simply because when you say online advertising, I think Google.
So although I agree they have high margins and they will decline over time. They won't decline because of small competitors, but the majors.
Contrast that with GOOG (and YHOO) whose users made conscious decisions to use their services. Who do you think has the more enduring relationship with their users? Whose services were chosen on their merits not because their users were captive?
Anyone who forecasts MSFT overtaking either GOOG or YHOO needs to start by addressing this issue. Just like Zune and its other offerings in competitive (non OS) environments, MSFT has shown clay feet.
GOOG and YHOO have to continue to earn it everyday, but they've shown the ability to compete and this race is theirs to lose, not MSFT's to win.
That's why other search engines which offer ads at lower cost (by pricing them inefficiently) haven't impacted Google's business, and why price competition isn't -- and won't be -- an issue for Google. You can't undercut free (for its users), and the advertisers will bid for the supply of ads based on the value to them.
Where Google is susceptible to price competition is in its AdSense business, where it doesn't disclose the share of ad revenue that it gives to small publishers. Another service could come in and give publishers a higher cut of the revenues, and displace Google. But Google's technology is so good, and its roster of advertisers so large, that so far that hasn't been a problem.