Saturday, December 10, 2005
How Not to Think Strategically, pt 173841
First, a quick note about the emerging buzz surrounding MS's plans to pay consumers for ads.
This may sound cool, but there are three big problems which render it strategically meaningless.
1) It's fraught with moral hazard = click fraud^1000000.
2) It's a very nice market for adverse selection. That is, the guys that will pay you the most to click on their ads will be exactly the guys you never want to see ads from.
2) Google can imitate it overnight.
There's a much better way to improve on PPC, but I unfortunately can't tell you what it is, since one of my clients is working on it.
Relatd to this, Nick C thinks Google is in trouble:
"...Moreover, it's been able to run its AdWords and AdSense services as black boxes, hiding to a large extent the way it divvies up the money that comes in. Advertisers and publishers haven't complained much because their choices have been constrained. In the end, though, markets abhor both black boxes and oversized profits."
I think this argument is fatally flawed. Two points to note:
1) Calculating Google's gross revenue share is trivial; all the numbers you need are in it's annual report. It's by no means "hidden" (though it may certainly be for individual publishers).
if you make this calculation, you'll see that by no means does Google "keep all the money to itself". In fact, a huge reason for it's near-total disruption of advertising is the fact that it shares the lion's share of revenues, creating huge incentives for competitors...not to compete, but to cooperate.
2) Markets abhor oversized profits?! Let me emphatically point out that nothing could be further from the truth.
In the simplest analysis, you can think of many different kinds of monopoly effects, or what you can call competitive advantage: local, natural, time-based, etc. Secondarily, you can think of what strategists call Schumpeterian (radical innovation) or Ricardian (scarcity) rents as different kinds of drivers of supernormal returns.
Intuitively, you can think about MS in the 90s, oil companies today, GM in it's heyday, Wal-Mart, Starbucks, IBM, Coke, blah, blah.
If markets "abhorred oversize profits"...the beta of every financial instrument would be 1. Clearly, it's not; hence, there's an existence proof that what Nick is arguing is off.
In fact, the opposite is true, as recent work in behavioural finance shows: markets exhibit neat positive feedback with respect to oversized profits, as information contagion causes expectations cascades. Markets luv oversized profits.
So the premises are bad. Does the conclusion of Nick's argument hold? Will Google's margins erode as competition picks up?
More than likely, not very much. The converse will be (and already is) true: competitors are engaging in serious price competition, to offset the disporportionately lower utility advertisers derive from advertising on smaller networks with less efficient transaction mechanisms. It's their margins that are eroding; this is the trend that's likely to continue.
If you really wanna know why, read my research note on Google Print - I don't have time to get into the details now.
I hate (hate, hate) ad-hominem arguments, but "Microsoft are going to pay people to click-on adverts, and Henry Blodget thinks it's a good idea"
It really is silly season, isn't it?
I suppose MS might be getting a kick-back from the advertisers if the customers actually *buy* something, and they share that. Eg. buy your next holiday via a link from us and get a 50c discount!!
(Actually, am I wrong to sneer? Perhaps credit cards are doing the same thing : buy via the Visa Network to get these benefits)
Surely the way for Yahoo and MS to attack Google is through knowing more about the clickers. MSN and Yahoo have more cookies on your machine. Yahoo particularly may know about your photo-searches on Flickr, bookmarks on del.icio.us, RSS subscriptions. All of this can be presented to the advertisers, individually (or in aggrogate if people scream) : Yahoo analytics. "The most popular tags / bookmarks from people who clicked on your advert are : ..."
// Composing // 3:48 PM
Your post is once again a great example itself of "how not to think strategically."
"Recent work in behavioral finance" indeed. How about centuries of economic theory, on the other side? Of course markets love outsized returns, until they become lower returns, which they inevitably do.
But I suppose you need to insist on such silly points of view in order to generate your consulting fees.
There are many ways to do what Gates is suggesting while avoiding the adverse selection problem. But I can't tell you because I'm working on them.
Markets tend to work against oversize profits because the larger your profit margin the easier it is for a competitor to offer the same service at a lower price.
If markets tended towards higher and higher profit margins, prices for everything would quickly become infinite.
As Anonymous and Scooby point out, the 'market' in this case is not the equity market (which of course loves a company that has high profits) but rather the advertising market which will see new entrants the higher the profit margins of the incumbents.
There are other arguments as to why oversized profits might be temporarily sustainable (say for a few years to a decade or so) in a network-driven industry. But the fact that equity markets love profits is unrelated.
There's another reason this is a bad idea -- another type of "adverse selection": The users most swayed by getting a kickback for the ads they view are the least-desirable users to be advertising to.
The amount of money that could be earned in this way by legitimate use would be only of interest to those whose time is worth very little -- i.e., they have very little money -- i.e., they're not good advertising targets.
I almost sense glee in the market Google is about to be tweaked. CIOs are far more worried about IBM's 100 b, Mircosoft's 40b, Oracle's 15b - v/s 6b for Google. Because they realize Microsoft has 87% gross margin, Oracle 75%...almost pure profit...CIOs would love a results based model like Google's instead of the lock-in pricing they have from so many vendors...
// Vinnie Mirchandani // 5:52 AM
I share Umair's concerns re these bold statements from BG and MS. But my major contra is that MS has never understood brand comms or customer experience well, and the challenges facing advertisers in 2.0 are almost overwhelming.
The shift from 'interruption of experience' to 'enhancement of experience' has the experts flumoxed to date. The amateurs - with respect - stand little chance of making it stick, and may risk looking plain foolish to the very audience they need to bowl over with true innovation.
// Michael Mouse // 8:51 AM
I agree with you - that info is far more valuable.
"..."Recent work in behavioral finance" indeed. How about centuries of economic theory, on the other side?"
Dude, did you even *read* my post? I covered "centuries of economic theory" in talking about monopoly effects and different kinds of rents.
"...Markets tend to work against oversize profits because the larger your profit margin the easier it is for a competitor to offer the same service at a lower price."
This is wrong; just think about Ferrari. Is it "easier" for real competitors (Lamborghini, Bentley) to underprice them because they earn fat margins? No.
I think that's a bit of a false distinction.
First, by definition, a firm's performance in equity markets is a reflection of it's advantage, etc; economically, they're flip sides of the same coin.
So, second, I am talking about both sides of the coin - there are many sources of advantage which yield supernormal returns; markets will luv you for this, not abhor you.
That is, the simple equation you are outlining - margins attract competitors which reduces market value - is by no means true; my post is basically noting that point, and offering some reasons why.
That is a killer point.
I'm not sure I get your comment, but I would like to.
That is a very good point.
Thanks for the comments guys.
I meant even with 87% gross margins Microsoft has not "refunded" in past much to anyone around its software..careful to take Bill's promise to do so around ads.
Also, he is trying to make Google sound bad with the comment of "keeping all the money to itself". Google is still a very small player in the overall scheme of things. CIOs are far more interested in different pricing models (more results based - advertising based or otherwise)and concessions from IBM, Microsoft, Oracle etc.
// Vinnie Mirchandani // 3:31 PM
Umair, I think you are confused on the "markets abhor super-sized profits".
The markets in this case are not the stock markets. They are the free market. Profits signal where capital should be deployed which eventually pressures the margins of the incumbent.
I agree, tho, that paying consumers to view ads is more lame than brilliant.
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