Looking into the Vortex of the Internet Economy

Google’s earnings remind us of the core competitive dynamic of the Internet content economy – the increasing market dominance of Google.

• Google’s 18% revenue growth Q407-Q408 during this economic maelstrom is extraordinary, especially when its secondary search competitor, Microsoft, posted zero growth in online services and 2% revenue growth overall.
• I expect Google’s growth to be even more impressive when compared to Google’s main competitor, Yahoo, which I expect to post ugly fourth quarter negative growth.
  • Yahoo has been in the corporate equivalent of a fetal position ever since the DOJ blocked its ad agreement with Google and it became obvious Yahoo had no “plan B.”
• I was even more impressed with Google’s dominance when I calculated that Google grew revenues over 31% in 2008 off a large $16.6b 2007 base. The law of large numbers did not take as big a bite out of Google as many expected.

As strong as Google’s revenue growth was, the most interesting earnings development to me was the big peek Google gave us behind its infamous secrecy curtain – in disclosing it was re-pricing most of its employee stock options.

• Google had no choice but to disclose this shareholder dilution in detail, because this is one type of forward-looking action that a public company can’t refuse to discuss publicly with shareholders.
• What did Google do?
  • Google re-priced employee stock options for the 85% of employees who had options that were ‘underwater’ or currently worthless to incent the last 17,000 employees Google has hired to stay with the company. 
•  What does this mean?
  • First, Google effectively transferred ~3% of Google’s future wealth from current shareholders to current employees.
  • Second, this tells us that Google’s leadership badly over-drove their headlights and did not at all anticipate that their stock price would do nothing but go up and up and up. Put another way, Google’s leadership incorrectly led 85% of its company, or 17,000 people, to believe that the option prices the company set for them would enable them to do very well financially. Oops! 
  • Third, if Google claims it is still in hiring mode, and still retains 300 recruiters after letting 100 go, Google’s 2H08 employee attrition numbers must have spiked much more than the company is letting on. Google campers aren't happy.   

Back to my main point, that Google is the vortex of the Internet content economy. The earnings call gave indications that Google’s dominance is increasing significantly.

• First, it doesn’t take a math genius to realize that Google is taking massive share in this downturn if: the economy is contracting; Internet advertising overall has slowed substantially, and Google grew 18% Q407-Q408 and 31% Y07-Y08.
  • The strongest Internet advertiser is getting much stronger.
  • In other words, the monopoly power that DOJ determined Google had in Internet search advertising and Internet search syndication in blocking the Google-Yahoo deal is getting even more dominant.
• Second, Google-owned sites are growing over five times faster than Google’s network of affiliated web sites. This means that Google’s main expense, its traffic acquisition costs (TAC) or revenue shared with competitors/affiliates, is going down as Google captures more and more of the profit in the Internet content economy and competitors capture relatively less and less.
  • This is not healthy Internet competition.  

Point to ponder: Why does the tech community obsess only about the problem of lack of competition in broadband, when broadband markets are more competitive and less concentrated than many tech markets – like search advertising?