First and foremost, this is a rather speculative article. No one knows how products will be perceived, what is over the horizon, or how the world will look in five years. That said, there are some interesting trends in tech that are worth a closer look. Investors need to form their own opinions but hopefully this article can provide some catalyst for thought.
With a $209.96 billion market cap and trading near 19 times earnings, investors need to evaluate what risks hang over Google's (GOOG) core business and how safe that business is. Somewhat recently, technology companies have begun rolling out more integrated product ecosystems that, if the companies choose, could begin to cut into Google's core business.
The big players in building integrated end-user experiences are Microsoft (MSFT), Apple (AAPL), Google, and Amazon (AMZN). Of course Microsoft holds the most secure and integrated product line in history with its Microsoft Office and Windows offerings, but more players are beginning to see the potential of offering consumers entertainment, productivity, storage, and search all in one package.
For Microsoft, it is keeping the enterprise tied to Microsoft Office, Windows, and the enterprise products that accompany them. For Apple, it is keeping customers tied to iTunes and iPods with Digital Rights Management (DRM), which was discontinued for music in 2009 but remains on movies, television shows, and other offerings in the store while providing integrated interfaces that keep consumers hooked. The addition of iCloud, which syncs data and files across all Apple devices, makes users more likely to purchase another Apple device in the future and less likely to use third-party applications that fall outside of Apple's seamless integration.
For Google, the recently launched Google Play looks to achieve the same in entertainment and application support while the new Google Drive and Google Docs offers a great (and free) productivity suite well-integrated with Gmail. Amazon's Prime and Instant Video offerings try to target entertainment along with e-books on its Kindle tablet. It remains to be seen whether or not Facebook (FB) will enter the foray, but with rumors of a mobile phone, search, and more video content on the horizon it is not a stretch to consider the possibility.
Microsoft has long held the leash of the enterprise market and does not appear to be relinquishing it anytime soon. Apple has exploded and captured the consumer market (both device and media) in a manner not seen since the years following Microsoft's Windows 95 and it remains to be seen if the company will ever focus on the enterprise market (it would not have happened under Jobs). Amazon remains focused on the consumer market and is a powerful player thanks in large part to the widespread use of Amazon.com, but lacks competitive device offerings other than the Kindle.
And then there's Google. It's important to understand exactly what Google is before proceeding because the company dabbles in so many spaces (some very interesting) that investors can lose sight of the core business. Despite popular perception, for investor's purposes Google is nothing more than an online advertising company. In fact, 96% of all of Google's 2011 revenues were derived from its various advertising programs. While this is set to change with the Motorola acquisition which will most likely add an 11% hardware element to the revenue stream, the core business remains the same. That advertising business will soon come under attack from Apple in the mobile space and Microsoft/Yahoo (YHOO) in traditional search.
Investors strive to avoid owning companies that have fierce competition in the primary space where they operate. Red flags here are low barriers to entry, an initially high margin business, and a large, highly visible, untapped market. While few would argue labor intensive software design and billion dollar data centers are markets with low barriers to entry, there are so many cash rich, capable players in the space that the effect is essentially the same. In other words, Google's primary businesses are not unique and protected as far as the company's big tech brethren are concerned. While a fantastic growth profile hides the initial impact of this competition it will not be long until that impact begins to grow and the adaptation of certain product ecosystems will allow the creators of those ecosystems to guide consumers towards the offerings they choose.
Apple's iPhone 5 sales alone are expected to be in the neighborhood of 100 million devices in its first year on the market. This is on top of the 365 million iOS devices (iPhones and iPads) currently on the market, most of which will be upgraded to iOS 6 as more than 80% of all iOS users are currently running the latest version (compared to 7% running the latest Android offering). The iOS 6 mobile operating system will continue purging Google products from the Apple ecosystem. Apple will already be replacing the Google Maps application with their own offering as well as eliminating the previously default YouTube application.
Perhaps the biggest change is unconfirmed but would be the easiest to execute. Google has always been the default search engine on iOS devices (anyone who has studied Internet Explorer market share knows the power of the default setting). If Apple simply switched the default search engine to one of the other offerings currently in Safari (Bing or Yahoo) Google would take a serious hit. Google knows this and reportedly pays Apple over $1 billion just to be the default choice on the company's various devices.
While Apple may not be willing to give up that kind of money just to continue purging Google from its systems, Microsoft has the money and the motive to step in. A recent article speculated on what Yahoo may want to do with the $6.3 billion in cash it will acquire from the recent Alibaba sale. The price will still probably be too high for Yahoo to outbid Google, but if Apple is really serious about cutting all ties with the search giant things may get interesting. Apple has worked with Yahoo extensively in the past and was the original IMAP e-mail provider for the iPhone as well as the data source for the weather and stock applications.
Mobile Device Operating System Market Share (click to enlarge)
In aggregate, this means a lot less clicks for Google's mobile advertising division which accounts for 34% of the value of the company's total stock price according to Trefis. This values mobile advertising 4% higher than traditional PC search advertising. With the acquisition of Quattro Wireless in 2010, Apple entered the advertising business. The result was iAd, which allows third party developers to embed advertisements into applications directly from Apple. At this years World Wide Developers Conference, Apple made it clear (as they have in the past) that mobile advertising will be 100% integrated with mobile applications which will allow Apple and developers to control more effective ad experiences. Combined with a search offering this could be a powerful combination. Apple has avoided such temptations in the past but this could change at any time.
Steve Jobs never wanted Apple to become like the Walt Disney Company. Following Walt Disney's death in 1966 the company was plagued by the phrase, "What would Walt do?" Of course this is a problem, because only a unique visionary like Walt would really know what Walt would do, and the same goes for Jobs. Jobs was acutely aware of this and wanted to ensure Apple would not fall victim to this mentality via his succession plan.
Why is this important? Because as Apple seeks new avenues for growth outside of the company's traditional offerings it will no longer be tied down by Jobs' aversion to moving away from core product lines, lines that Apple is best of breed in. Whether or not that would be prudent is arguable, but by moving forward with e-mail, maps, and calendars on top of the already strong media offerings in iTunes, search and advertising may be a natural progression. Imagine the power of Siri (Apple's AI voice assistant) backed by a tailored search engine with Apple-backed advertising. Google investors need to establish strong reasons for believing this will not happen lest they face a world where Microsoft centers its products around Bing while Apple centers its around a new search product.
Speaking of Bing, Microsoft is literally paying users to use Bing (seriously, check it out). If paying users to use a free product is not the epitome of an increasingly brutal market for search providers what is? Anyone who mentions the Bing threat to Google tends to get laughed at because the market share numbers are dwarfed by Google's.
But Bing is relatively new to the scene and Microsoft is about to release a new, integrated product line spanning from smartphones, to tablets, to PCs with Windows 8. Like Apple has incentive to de-prioritize Google's mobile advertising for its own offering, Microsoft now has the same incentive for traditional PC search as well as any future mobile offerings. In other words, as powerful as the Google brand is, the vast majority of new devices hitting the market in the foreseeable future (including PCs) are going to be moving away from the Google ecosystem and why not? Microsoft and Apple both see the potential in advertising and are already further integrating their offerings to pursue it both in mobile (iAd) and traditional search (Bing).
The new Outlook.com reveal shows Microsoft is aiming directly at Gmail. The goal being to roll out an integrated product suite with e-mail, chat, Microsoft Office, and Skype all in one offering. Skype will now be integrated into Outlook.com and work in sync with the e-mail client. This is a great way for Microsoft to leverage its Office foothold in the enterprise in order to gain more consumer users. This directs more traffic away from Google and attacks Google's goal of moving functions such as e-mail and video conferencing into the cloud with an alternative offering that will surely gain an immediate foothold in the enterprise market. However, the real impact may not be felt until more devices begin running Windows-based operating systems. The Windows dominance has not hurt Google yet, but look for Microsoft to prioritize Bing and integrate it further into the operating system in an attempt to drive traffic.
The defection of Marissa Mayer from Google to Yahoo is probably over-covered but deserves a look nonetheless. Mayer held a prime position at Google and was responsible for some of the company's best consumer offerings such as Gmail. Yahoo is an interesting company that beat Google to the market (1995 vs. 1998) but failed to gel with consumers and advertisers the way Google did. Apple has been working with Yahoo since the first iPhone in 2007 and may very well make Yahoo the default search option and begin partnering with the company on other online products they do not want to develop in-house as they continue to migrate away from Google. Mayer would be more than pleased to land more of Apple's business to kick off her term as CEO. After all, Yahoo does not make phones and tablets, and the company is desperate.
A recent article on Facebook referred to the American Customer Satisfaction Index to display problems that may be lurking within the company's large user base. The ACSI is a great way for investors to keep tabs on consumer sentiment (albeit with a grain of salt). The numbers may be a way to spot consumer trends before they begin making a visible mark on the various companies that interest investors.
The search engine market (and thus the internet advertising market) allows for a high degree of consumer choice. For a consumer to switch from Google to Bing or vice versa costs almost nothing. Therein lies the value of tethering consumers to certain offerings via either hardware defaults (most consumers search without thinking) or via other internet service offerings such as Gmail, Yahoo Mail, or Outlook.com. What should be disturbing to the Google investor is there is very little disparity between Google search and the other two major offerings as far as consumer satisfaction is concerned. In other words given the default hardware or ecosystem directed opportunity, there is really nothing holding users to Google. Soon users will get their hands on new iPhone 5s, iPads, and Windows 8 tablets in addition to PCs all directing users away from Google towards other offerings.
Investors need to ask two questions: Will users remain loyal to Google because it is Google? (That did not work with Yahoo.) Or will consumers prefer Google's hardware, software, and internet services ecosystem over offerings from Apple and Microsoft, who have established a strong grip on the consumer and enterprise markets, respectively? Investors should look for strength in one or the other before establishing a long position in Google at current levels.
While Google's software flexibility with Android may keep the company relevant, Microsoft and Apple have stronger and more established ecosystems supported by both desktop and mobile operating systems. The enterprise will be sticking with Microsoft and consumers will continue to flock towards Apple. Microsoft has already created a formidable alternative to Google with Bing while Apple has clearly begun moving away from Google altogether. Investors should keep an eye on Apple's acquisitions in case the company begins to expand its advertising efforts into traditional search as the company did in mobile search with iAd.
Google is not going anywhere, and will be a strong player for the foreseeable future. But moves into hardware and the Android operating system indicate the company sees the threat from established product ecosystems and is attempting to respond. An investor should track how successful those offerings are and adjust her prospects for the advertising business accordingly. So far Google has more than held its own, but as competitor hardware from Apple and Microsoft gets cheaper and competitors begin taking a bite out of the search market whether or not Google will be able to maintain its stellar growth and advertising foothold is questionable. Regardless, there is no doubt that the two premier software companies in the world will be moving customers away from Google and towards alternative offerings. Google investors need to find reasons why this will not hurt the company.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.