Four Implications of Google Sidebar (CNET, DJ, FWHT, GOOG, IACI, INSP, MSFT, TSCM, YHOO)

Four investment implications of Google (ticker: GOOG) Sidebar, released today:

1. Don't forget this is a defensive move

Google faces a looming threat to its core business of monetized Web search from Microsoft (ticker: MSFT). As search is embedded in applications such as Web browsers (eg. Firefox and Safari) and desktop search (through the PC operating system), Google becomes vulnerable to the providers of those applications. That means Microsoft. The next generation of Internet Explorer contains embedded MSN search, and Microsoft's desktop search - when Longhorn eventually ships - will use MSN search for Web pages. It's therefore imperative that Google establish a user-base for its own applications and also discourage users from adopting Microsoft applications, as that will be the only way for Google to maintain its search market share.

Anecdotal and speculative illustration of this: note that in the screen shot provided by Google of its Sidebar, the Quick View has a link to Mozilla Firefox Start Page. Google does not want you to use Internet Explorer.

Investors may be wowed by the elegance of Sidebar and the prospect of Google entering Microsoft's territory. There will be lots of speculation that the Scratch Pad function and Google's insertion of its own search into Outlook are the first signs of an assault on Microsoft Office. But they need to remember that Google has no choice, and that asking users to download an application is a tougher sell than pre-loading software on every new PC.

2. Watch out Yahoo!

Google Sidebar poses the clearest competitive threat to Yahoo (ticker: YHOO). Google's integration of direct access to movie information and stock quotes within Google search has already demonstrated that Yahoo's approach of requiring users to visit topic-specific Web pages as a gateway to information is outdated and inefficient. If Google gets traction with Sidebar, users will find that it's a more convenient way of accessing weather info, news, stock quotes and photos, as well as email, than going to Yahoo.com and finding the appropriate links.

Some critical elements are still missing from Sidebar. Google needs to add instant messaging and probably personal web publishing to the tool. Google, Microsoft and Yahoo are all grappling with the question of what an intregrated information, communication and publishing toolset should look like, and how to balance a full set of features with simplicity of use. But it's clear that they're all on a collision course.

Yahoo, however, is most vulnerable. It's currently the leading provider of Web content and "sticky" services like Web email and stock quotes, and therefore has the most market share to lose. Despite Terry Semel's optimism about embedding search on Yahoo's content pages, Yahoo has been losing market share in search. It's hard to see how that will be reversed, given Google's core competency in search and Microsoft's looming market share gains via application embedding. Yahoo lacks Google's aggressive creativity and Microsoft's application and OS dominance.

3. Another boost for small content providers

The pendulum is swinging in favor of small, niche web publishers away from larger publishers. First, the cost of Web publishing has fallen to practically zero, allowing the creation of single-subject Web sites. Second, search engines favor niche sites over more general sites. And third, RSS (Really Simple Syndication) allows users to read and track multiple topic-specific web sites when previously that wasn't easy.

One key innovation in Google Sidebar will further propel this trend: Google Sidebar automatically adds to your Sidebar RSS feeds from Web sites you frequently read. This is a significant improvement over My Yahoo, where users are forced to look for "Add to My Yahoo" buttons on Web sites, to search for RSS feeds themselves, or to choose from Yahoo's pre-selected directories. This smarter, more user-friendly approach to RSS will be adopted by Microsoft, Yahoo, Mozilla and Apple in time.

By improving the automatic distribution of high-quality web content and reducing the value of established brands, this development further levels the playing field between small and large Web publishers. Web sites will increasingly compete on quality of content. Niche, category-killing sites will gain share.

Stock implications? Bad for CNET (ticker: CNET, full disclosure: I'm short the stock), Yahoo, MarketWatch (owned by Dow Jones, ticker: DJ), TheStreet.com (ticker: TSCM, full disclosure: I'm short the stock) and other diversified content providers with established brands but insufficiently differentiated content.

4. Rising cost to play in the Web search market

Google's stock price assumes future strong revenue growth with healthy margins. Investors are assuming that the cost of maintaining Google's market share will not change significantly, and its gross margins are sustainable. That, despite the fact that Google's recent filing explicitly states that investors should expect decelerating revenue growth and declining margins.

Google Sidebar ups the costs of the Web search business. It's now no longer enough to employ a group of super-smart software engineers and maintain a bare-bones Web site. If you want to compete in the Web search market, you're going to have to provide desktop software, maps, communication and publishing tools and - increasingly - your own proprietary content. All of which will be given away for free, but cost money to develop.

This will have two ramifications. First, the search market will shake-out. Google, Microsoft and Yahoo are all focused on the monetized-search market, and all will spend what it takes to compete. Others, like Amazon (ticker: AMZN) and Ask Jeeves (ASKJ, now owned by Interactive Corp, ticker: IACI) will have to decide. Forget the tier 2 search companies like Infospace (INSP) and FindWhat (FWHT).

Second, for the remaining players, investors should expect that search margins will decline over time as the costs to play rise faster than investors currently foresee. You read it here, then in Google's own SEC filing, then here again...

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Full disclosure: at the time of writing I'm short CNET and TSCM.