Tuesday, May 24, 2005

You Can’t Underprice Free


Bill Gates is not used to losing.

But his company and its government-sanctioned monopoly on desktop operating systems is losing big time as the world moves away from doing things on computers to doing one main thing with computers.

That one main thing being, of course, getting on the Internet.

Once on the Internet, people can read the news, visit their friends, plan trips, buy cars, order the groceries, trade stocks, get a college degree, run their business—and when they flick on their computers, what people care about is finding all that stuff quickly and easily.

What people used to care about when they flicked on their computers was using the newest versions of Excel and Word, Start-buttons and tabs and self-adding tables and insertable charts—stuff that, nowadays, is taken for granted while you're searching for something out in the real world.

And since Microsoft really excels at things like Start-buttons and tabs and self-adding tables—the stuff that's taken for granted—but does a horrible job helping people use the Internet, Google is running away with the ball.

Actually, Google is running away with the advertisers who want to reach those internet users utilizing Google to find what they want. So what we have is an internet-based company in business not to generate “eyeballs” or “reach” but to generate real revenue.

And Google generates plenty of real revenue.

Two years ago, Google’s first quarter advertising sales were not quite $250 million, while the New York Times generated $783.7 million in advertising sales.

This year, however, Google’s first quarter sales exceeded $1.2 billion. Meanwhile, the Times generated $805.6 million in sales.

In other words, Google’s sales grew almost a billion over a two year period, while the Times’ sales grew a little over $20 million.

Oh, and the Times was founded in 1851. Google was incorporated in 1998.

This is why the newspaper industry—and I have owned McClatchy, a very well-managed California newspaper chain, for many years—is in more trouble than it wants to know.

But it is also why Bill Gates is getting—excuse the word—bitchy. He’s not accustomed to losing, and his company is losing ground very quickly.

Just yesterday Gates, like a whiny rich guy—hey, he is a whiny rich guy—whined about Google at a Wall Street Journal technology conference.

Reports today’s New York Times:

“Google is still perfect, the bubble is floating and they can do everything,” Mr. Gates told the moderator sarcastically…

Meanwhile, Gates was announcing the availability of…drum roll…satellite imaging technology that would be available—as always, with Microsoft, some time in the future.

Google, of course, has had satellite imaging up and available since last year.

“There’s going to be a lot of competition in the mapping area,” Gates said, ominously. He promised Microsoft’s mapping service would take things to “a whole new level.”

What Gates doesn’t get, however, is that it’s not about satellite mapping. It’s about search. The maps—Google’s maps are far better than anything Mapquest offers—and the satellite images and the rest of what Google offers is all about keeping you on their search engine.

And since Microsoft’s basic business is encouraging people to buy computers loaded with Microsoft software which does stuff nobody really cares about any more, while Google’s basic business is providing people the best way to navigate the internet—which is what everybody cares about—Gates is probably going to be whining for a long time.

I’m not saying Microsoft will never catch up to Google, technology-wise. One thing about Microsoft—and I made a career out of shorting companies such as Lotus, Netscape, Borland and Novell after Microsoft targeted them for certain death—is they always spend the money and they always, eventually, get the technology good enough for a user to switch to the low-priced version.

But in the case of Google—as with Adobe’s PDF technology—Google is available for free. Therefore, Google has no price structure to defend, except in the advertising world. And as long as Google has the user base to attract the advertisers, Bill Gates will be hard-pressed to undermine Google’s position as the Interstate Highway System of the Internet.

Because you can’t underprice free.


Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.



10 comments:

MD said...

Excellent analysis of the competitive dynamics of Google and Microsoft.

Three questions.

1. What do you make of the allegations of click fraud? There have been numerous anecdotes of firms paying people to click on links.

2. How much of Google's growth has been fueled by mortgage & credit card customers? A lot, I believe. I think back to Yahoo's early missteps where it had been too reliant on dot-coms -- do you think Google faces a similar problem?

3. Have you tried Picasa? It's the best photo software out there, in my opinion. And it's tightly integrated with Hello and Blogger.

cdub said...

A lot of this sounds somewhat familiar to me (despite attempts to purge my memory of the dot-com bomb). A dot com company creates some superior technology, users flock in droves, market cap explodes. And yes, Google is making obscene amounts of money. But I just don't see the "big future" here. I have yet to spend a dime on anything Google offers, and likely never will. Sure, they get advertising dollars because I use their search engine, but weren't we saying that about Excite, Lycos, et al a few years ago? Google is different. But how different? $73 billion?
As for Microsoft, their plight is fairly similar to the enterprise software battle - value will only accrue at the application level, where people actual use (and care about) the functionality. The database/operating system/tools level is no longer important. Hence an Oracle spending spree, which is likely to continue.

poletown said...

As always Jeff, an excellent review of the topic at hand. I recently read an in-depth article on Bill Gates hatred for Google in Money magazine, and it sounds as if he's going a little off the deep end. Staffers say that he believes Google office is inevitable, and that a Google O/S is a real possibility.

Microsoft isn't used to leading the market through innovation, but rather through monopolistic practices and intimidation. Google (and to a lessor degree, Linux) are two entities that Microsoft can't crush using their traditional methods.

Now, Microsoft will actually have to compete blow for blow in order to catch Google, and they aren't used to that. As you say, you can't be free - especially when free is loaded with so many cool features. Sure, Microsoft is sitting on a huge pile of cash, but they will have to create something truly groundbreaking to cut into Google's marketshare with any signifigance. The traditional Microsoft vaporware release strategy won't work here, because Google is lean and fast.

The one thing I worry about at Google longterm, is widespread click fraud. I don't understand how they will be able to accurately control that as scam artists and spammers become more savvy. To a lessor degree, I also worry about their stock price. Sure, Google is an excellent company, and I think they will grow long into the future, but it seems like their shares are already overvalued. At over $200 each, I think were destined to see them drop in the next year or two.

Again - excellent job Jeff!

--Craig (poletown.blogspot.com)

Jeff Matthews said...

"md": Click fraud is a real concern, but I think--like credit card fraud--it will be dealt with.

Just last night our Mastercard got cancelled because somebody hacked into a restaurant and got all the credit card numbers. Mastercard is reissuing a card. The whole process is costing them money, but it's just a part of the cost of being in that business.

Credit card fraud didn't stop credit cards from being pervasive, and I don't think click fraud will shut down the online search/advertising model, either, even if the policing and preventing of it becomes a cost of the model.

As for whether the online search model has benefited from the mortgage/credit card boom, I would guess the answer is yes, but have no idea by how much.

I can tell you by the dreadful advertising results at the major newspaper chains in the last two years that money is starting to flow away from old media in search of where the consumer has gone, which, in many cases, is the internet.

And yes, I have used Picasa, and it is terrific, although still a couple of revisions away from being as user-friendly as the Mac's photo software.

As for "cdub"'s comment that he has yet to "spend a dime on anything Google offers," well...that's the point. No Google user ever HAS spent a dime. It's free--whether you use search or maps or froogle or blogger... So even if you wanted to spend that dime with Google, you wouldn't have an opportunity, unless you were an advertiser.

The dimes that are being spent are by the advertisers who are looking to reach the people using it, just like radio and television advertisers. I would imagine you have never spent a dime on CBS televsion or WFAN radio, either, but that doesn't mean they don't exist, and they don't make money.

As for the longevity of the model, and the valuation attached to the model, that's what markets are for. Yahoo was written of as an Excite-type piece of fluff, and last year generated $3.5 billion revenue. Many others have come and gone.

Time will tell.

Its_strange said...

NYTimes said it will start charging to read its online editorial stuff .

ikedim said...

Great blog, Jeff - just came across it a few days ago. Keep it up!

I do think you may be underestimating the threat from Microsoft. They may not have the option to underprice to the user, but they could certainly undersell to the advertiser. Why wouldn't the following strategy work:

1) Integrate search from every conceivable place in the next releases of their apps/OS.

2) Undercut Google pricing to advertisers.

This wouldn't kill Google, but it could certainly cut off some of their air supply ...

Tom M said...

I find I am using Google searches less and less. Certainly, when I need to find what 'I' want (not what I'm pointed to), I use, or add, other search engines. This is where Microsoft will, or at least where Microsoft can, win. It can make searches more relevant, because it doesn't 'need' to point searches blatantly to it's advertiser base. More and more, Google's searches come up lamely pointing me at a sales pitch, forcing me to filter the results myself, almost like filtering spam from my email.

Google is not free if it wastes my time hawking it's sponsors at me. Whereas Microsoft can be, if only to put the "Netscape*" on Google.

*remember when Netscape was going to make Microsoft irrelevant...

Jeff Matthews said...

I'm confused. Google searches are based on links to the site deemed most relevant to the search, they are not pointing the user to an ad. Advertisements are added alongside the search results. I don't see how this "points searches to its advertising base."

As for Microsoft, they are absolutely the threat in precisely the way "ikedim" suggests--integrating search into Longhorn and cutting deals with the advertisers that undercuts Google.

This is why I pointed out that Microsoft will get the technology right, but they can not merely undercut Google by giving away a search engine for free, like they did Netscape...because Google is free, while Netscape charged for the browser. The key is the advertisers.

However, all that presupposes that Microsoft releases Longhorn in our lifetime. And I have a theory about that: I think Microsoft is under so much attack from the terrible flaws in their existing OS that they will not get Longhorn out anywhere near the already-pushed-back launch date. You can't fight a battle on two fronts.

But, as I said, time will tell.

Roberto said...

Jeff I really think you are down playing the threat of click fraud. The reason I say that is the fraudster are becoming far more sophisticated at what they do. If you have a team of clickster all over the world how the heck is Google or any online advertiser going to stop that? You can't. Trust me they're clever enough to hide there tracks and they know how Google polices the clicks. I wonder right now what % of Google's revenues are even legit? Is it 60%, or maybe 70%? Once advertisers understand how big the problem is I think it could really hurt Google's earnings. I don't think this happens overnight, so please understand where I am coming from.

Read this link for a bit of an idea of what I am talking about.
http://www.webpronews.com/insidesearch/insidesearch/wpn-56-20050517ClickFraudBeingOfferedByEmail.html

Let's remember another thing here Google has no product, so any long term damage to there business model leaves them with almost nothing to fall back on. What is stopping someone from coming up with a superior way to search and competing with Google? I don't see many barriers to entry. Microsoft could tie in some neat new search feature with there OS and kill Google. For some reason my gut is telling me Google is pie in the sky and it wont be nearly as great of a stock or corporation in 5 years from now. That doesn't mean I will stop trading it though. I just wouldn't invest in it.

k9thunder said...

I'm an ex-Microsoft Program Manager and shared building with MSN (Redwest B). Rick Belluzo office was almost right above my office on the 3rd floor for few months before he got promoted then ousted.

The confidence and arrogance within Microsoft is amazing. It's as though confidence exuding from insecurity and ignorance. Combine that with bunch of aggresive, take no prisoner and often naive approach and result is bumbling and failed attempts within Microsoft many outsiders rarely hear about. Microsoft often pulls the plug on program easily.

Anyway, I think BillG got to be scared... Afterall MS started it's monopoly by paying mere $30k for DOS. MS just took Google for granted and didn't think much of it until it became household name led by ex-Novel CEO Schmidt and not the 2 wonder boys.

Google thinks high and way ahead into the future and if they can execute then they'll be on hot trails after MS. Just look at the technology cycle. Mainframes dominated by handful, miniframe with DEC/HP/IBM, PC and next computing just might be the terminal powered by Google...