The next few weeks will likely see a flurry of predictions for 2005, to the point where you'll be sick of reading them. So instead, I'm providing something which I hope will be more useful for investors in Internet stocks and managers of Internet companies: a checklist of danger signals for Internet investors to look out for next year. For each danger signal, I've specified which stocks will subsequently be at risk:
Danger Sign 1: Microsoft announces an early release date for the next version of Internet Explorer.
Microsoft's track-record of delaying the release of Longhorn, the next version of Windows, has lulled Internet investors into a false sense of security. They expect that the only change they'll see in the browser market is that Firefox will continue to gain market share.
But this is a mistake, because it ignores the relationship between the browser market and the search business. Most people's choice of search engine will be determined by the browser they use, so Microsoft is strongly incented to release an improved version of Internet Explorer. That release will provide much of the functionality that currently induces people to switch to Firefox. Like Firefox (and Safari), it will have search conveniently embedded in the browser, so you can search without having to go to a search engine's home page. But unlike Firefox, which defaults to Google, the next release of IE will default to Microsoft search. Once that happens, Microsoft will rapidly gain share in the search market.
Stocks at risk: Ask Jeeves, Google and Yahoo!.
Danger Sign 2: Microsoft announces a firm release date for Longhorn, including integrated desktop and Internet search.
What client will most people use to access the Internet? Maybe the browser, maybe a combined tool that searches locally stored files and remote data. Danger Sign 1 covered the former; this covers the latter. Local file search will be integrated into the operating system, if Microsoft's past behavior is any guide to the future. If Microsoft
combines local file search with search of remote data (Web pages and publicly accessible databases), then it has a strong probability of winning the search market and the pay-per-click ad business that goes with it.
Stocks at risk: Ask Jeeves, Google and Yahoo!.
Danger Sign 3: Category-killer Web sites get organized.
Investors tend to ignore trends until they affect the financial results of public companies. As a result, they've missed 4 critical changes that are transforming the Internet: (i) Web sites have become easy and cheap to create and maintain. (ii) Automated advertising technology enables advertising supported Web content businesses without requiring the hiring of advertising sales teams. (iii) Search engines favor frequently updated, category-killing Web sites. (iv) RSS makes it feasible for Web users to keep track of and view content from multiple small Web sites on a regular basis.
Put these trends together, and this is what you get: the creation of niche, category-killing, advertising-supported Web sites that get high placement in algorithmic search engine results and, once discovered, attract repeat-readers.
We've seen the first stage of this in the stunning proliferation of blogs. (Investors are generally unaware of this, because no blogging companies are public and Google doesn't talk much about Blogger.) The next stage will occur when Jason Calacanis' Weblogs Inc. and Nick Denton's Gawker Media successfully complete IPOs, and other bloggers start to organize themselves into sites with critical mass (multiple authors) and networks.
Once that happens, category-killer Web sites will take serious eyeball-share. If you want to read about cell phones, you'll go to Phone Scoop, Mobile Tracker or MobileBurn, instead of CNet. If you want to track Internet stocks, you'll come to The Internet Stock Blog because all it does is provide news and analysis of Internet stocks, and as a result it does that better than Yahoo!, CBS MarketWatch, TheStreet.com, and MSN Money.
Some readers will still want their information broad and shallow, but many others will want it narrow and deep.
(For greater depth on this issue see Four emerging Internet trends for investors and Internet investing: A new world of fragmentation and transparency.)
Stocks at risk: CNET, Yahoo!, TheStreet.com, CBS MarketWatch/Dow Jones.
Danger Sign 4: Offline retailers become more effective online retailers.
We've always known that multi-channel (offline and online) retailers have certain advantages over purely online retailers. They have established brands, they can spread their marketing costs over their store-based and online businesses, and they can advertise their online businesses in their physical stores. But until now they haven't worried investors who own the stocks of the pure-play online retailers.
That may change in 2005, as more offline companies improve their online operations. That could have two effects. They could simply take market share. But even if they don't gain significant market share, they'll drive up the price of online advertising.
You would have expected the leading Internet retailers to have sufficient brand recognition by now that they wouldn't be dependent on recurring advertising for customer retention. But that doesn't seem to be the case. Perhaps people who shop online pay less attention to the store they buy from and thus have less brand loyalty. Perhaps the
Internet makes it easier to compare prices, and that weakens loyalty. Whichever it is, increased competition and rising advertising costs will hit the online retailers' bottom lines.
Stocks at risk: Amazon, Blue Nile, BlueFly, eBay, eCost, Netflix, Overstock.
Danger Sign 5: Category-specific search starts to become truly effective.
When most Internet investors think of search, they think Google, Yahoo! and maybe Ask Jeeves. They don't think Amazon, eBay and Expedia. But they should. EBay brings together buyers and sellers by providing (i) a platform for sellers, (ii) search capabilities that allow buyers to find what they want, and (iii) a mechanism for reputation evaluation. In addition to selling its own inventory, Amazon provides (i) a storefront and transactional platform for third party retailers and (ii) search and personalisation tools to help buyers find what they want. Expedia, Travelocity and Orbitz can be viewed as search engines optimized for travel.
Which begs the question: what happens if search engines become much better at category specific search? This could happen in two ways: the development of category specific search engines, or the inclusion of category-specific search in general search engines.
We're already seeing specialized search engines. Comparison shopping engines are really shopping specific search engines, Kayak is a travel-specific search engine, and eGuide is an event listings search engine. We're also seeing the inclusion of more effective category specific search in general search engines: MSN Search, for example, offers filtered search for movies, stock quotes and shopping.
At some point the search engines will recognize queries as category specific requests. Type in "JFK to LAX 1/21/05 return 1/31/05", for example, and it's not unthinkable that Google will produce a list of flights. Type in "10 year fixed rate mortgage LA" and you won't need BankRate. Type in "Ford Taurus used $3000-4000" and it's not unthinkable that... well, you get the idea.
Achieving that quality of search result will be easier where the underlying markets are more concentrated, harder where they're more fragmented. Web services, for example, should allow the airlines and large hotel chains to provide structured data feeds optimized for their category to the search engines. Individual sellers of collectibles might be less accessible.
Stocks at risk: Amazon, IACI/Expedia, Sabre/Travelocity, Cendent/Orbitz, Priceline, Travelzoo, CTrip, BankRate.com and maybe eBay.
That's it. Your comments are welcome. Meanwhile, I wish all the readers of Seeking Alpha, The Internet Stock Blog and Sound Money Tips
a happy and healthy 2005.
Full disclosure: At the time of writing, I'm short CNET and TSCM, long HOLL and SHOP. As always this is not a recommendation to buy or sell stocks.