Google’s MVNO: What’s Behind it and What are the Implications?

Google’s core business is under pressure

Google, the undisputed leader in online advertising and tech industry icon, has more problems than you might think. The grand narrative is captured in the following chart, showing basic annual financial metrics for Google, Inc. between 2009 and 2014.

Figure 1: Google’s margins have eroded substantially over time

Source: STL Partners, Google 10-K filing

This is essentially the classic problem of commoditisation. The IT industry has been structurally deflationary throughout its existence, which has always posed problems for its biggest successes – how do you maintain profitability in a business where prices only ever fall? Google is growing in terms of volume, but its margins are sliding, and as a result, profitability is growing much more slowly than revenue. Since 2010, the operating margin has shrunk from around 35% to around 25%, a period during which a major competitor emerged (Facebook) and Google initiated a variety of major investments, research projects, and flirted with manufacturing hardware (through the Motorola acquisition).

And it could get worse. In its most recent 10-K filing, Google says: “We anticipate downward pressure on our operating margin in the future.” It cites increasing competition and increased expenditures, while noting that it is becoming more reliant on lower margin products: “The margin on the sale of digital content and apps, advertising revenues from mobile devices and newer advertising formats are generally less than the margin on revenues we generate from advertising on our websites on traditional formats.”

Google remains massively dependent on a commoditising advertising business

Google is very, very dependent on selling advertising for revenue. It does earn some revenue from content, but most of this is generated from the ContentID program, which places adverts on copyrighted material and shares revenue with the rightsholder, and therefore, amounts to much the same thing. Over the past two years, Google has actually become more advert-dominated, as Figure 2 shows. Advertising revenues are not only vastly greater than non-advertising revenues, they are growing much faster and increasing as a share of the total. Over- reliance on the fickle and fast changing advertising market is obviously risky. Also, while ad brokering is considered a high-margin business, Google’s margins are now at the same level as AT&T’s.

Figure 2: Not only is Google overwhelmingly dependent on advertising, advertising revenue is growing faster than non-advertising

Source: STL Partners, Google 10-K

The growth rate of non-advertising revenue at Google has slowed sharply since last year. It is now growing more slowly than either advertising on Google properties, or in the Google affiliate network (see Figure 3).

Figure 3: Google’s new-line businesses are growing slower than the core business

Source: STL Partners, Google 10-K

At the same time, the balance has shifted a little between Google’s own properties (such as Google.com) and its affiliate network. Historically, more and more Google revenue has come from its own inventory and less from placing ads on partner sites. Costs arise from the affiliate network because Google pays out revenue share to the partner sites, known as traffic-acquisition costs or TACs. Own-account ad inventory, however, isn’t free – Google has to create products to place advertising in, and this causes it to incur R&D expenditures.

In a real sense, R&D is the equivalent to TAC for the 60-odd per cent of Google’s business that occurs on its own web sites. Google engineering excellence, and perhaps economies of scale, mean that generating ad inventory via product creation might be a better deal than paying out revenue share to hordes of bloggers or app developers, and Figure 4 shows this is indeed the case. R&D makes up a much smaller percentage of revenue from Google properties than TAC does of revenue from the affiliate network.

Figure 4: R&D is a more efficient means of generating ad inventory than affiliate payouts

Source: STL Partners, Google 10-K

Note, that although TAC might well be rising, the spike for Q4 2014 is probably a seasonal effect – Q4 is likely to be a month when a lot of adverts get clicked across the web.

 

  • Executive Summary
  • Google’s core business is under pressure
  • Google remains massively dependent on a commoditising advertising business
  • Google spends far more on R&D and capex than Apple
  • But while costs soar, Google ad pricing is falling
  • Google also has very high running costs
  • The threats from Facebook and Apple are real
  • Google MVNO: a strategic initiative
  • What do you need to make a mini-carrier?
  • The Google MVNO will launch into a state of price war
  • How low could the Google MVNO’s prices be?
  • Google’s MVNO: The Strategic Rationale
  • Option 1: Ads
  • Option 2: Straightforward carrier business model
  • Option 3: Android-style strategic initiative vs MNOs
  • Option 4: Anti-Apple virus, 2.0
  • Conclusions

 

  • Figure 1: Google’s margins have eroded substantially over time
  • Figure 2: Not only is Google overwhelmingly dependent on advertising, advertising revenue is growing faster than non-advertising
  • Figure 3: Growth in Google’s new-line businesses is now slower than in the core business
  • Figure 4: R&D is a more efficient means of generating ad inventory than affiliate payouts
  • Figure 5: Google spends a lot of money on research
  • Figure 6: Proportionately, Google research spending is even higher
  • Figure 7: Google’s dollar capex is almost identical to vastly bigger Apple’s
  • Figure 8: Google is startlingly capex-intensive compared to Apple, especially for an ad broker versus a global manufacturing titan
  • Figure 9: Google’s ad pricing is declining, and volume growth paused for most of 2014
  • Figure 10: Google is a more expensive company to run than Apple
  • Figure 11: The aircraft hangar Google leases from NASA
  • Figure 12: Facebook is pursuing quality over quantity in ad placement
  • Figure 12: Facebook is gradually closing the gap on Google in digital advertising
  • Figure 14: Despite a huge revenue quarter, Facebook’s Q4 saw a sharp hit to margin
  • Figure 15: Facebook’s margin hit is explained by the rise in R&D spending
  • Figure 16: Apple’s triumph – a terrible Q4 for the Android ecosystem
  • Figure 17: Price disruption in France and in the United States
  • Figure 18: Price disruption in the US – this is only the beginning
  • Figure 19: Defending AT&T and Verizon Wireless’ ARPU comes at a price
  • Figure 20: Modelling the service price of a mini-carrier
  • Figure 21: A high WiFi offload rate could make Google’s pricing aggressive
  • Figure 21: Handset subsidies are alive and well at T-Mobile

 

Digital Commerce: Time to redefine the Mobile Wallet

Summary: The ‘Mobile/Digital Wallet’ needs to evolve to support authentication, search and discovery, as well as payments, vouchers, tickets and loyalty programmes. Moreover, consumers will want to be able to tailor the functionality of this “commerce assistant” or “commerce agent” to fit with their own interests and preferences. Key findings and next steps from the Digital Commerce stream of our Silicon Valley 2013 brainstorm. (April 2013, Executive Briefing Service, Dealing with Disruption Stream.)

Who is best placed to win in local commerce April 2013

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Below are the high-level analysis and detailed contents from a 35 page Telco 2.0 Briefing Report that can be downloaded in full in PDF format by members of the Telco 2.0 Executive Briefing service and the Dealing with Disruption Stream  here. Digital Commerce strategies and the findings of this report will also be explored in depth at the EMEA Executive Brainstorm in London, 5-6 June, 2013. Non-members can find out more about subscribing here, or to find out more about this and/or the brainstorm by emailing contact@telco2.net or calling +44 (0) 207 247 5003.

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Introduction

Part of the New Digital Economics Executive Brainstorm 2013 series, the Digital Commerce 2.0 event took place at the InterContinental Hotel, San Francisco on the 20th March and looked at how to get the mobile commerce flywheel moving, how to digitise local commerce, how to improve digital advertising and how to effectively leverage customer data and personal data. The Brainstorm considered how to harness telco assets and capabilities, as well as those of banks and payment networks, to deliver Digital Commerce 2.0.

Analysis: Time to redefine the wallet?

The Executive Brainstorm uncovered widespread confusion and dissatisfaction with the concept of a digital or mobile wallet. Some executives feel that a wallet, with its connotations of a highly personal item that is controlled entirely by the consumer and used primarily for transactions, may be the wrong term. There is a view that the concept of a digital wallet may have to evolve into a more multi-faceted application that supports authentication, search and discovery, as well as payments, vouchers, tickets and loyalty programmes.

Moreover, consumers will likely want to be able to tailor the functionality of this “commerce assistant” or “commerce agent” to fit with their own interests and preferences, rather than having to use an inflexible off-the-shelf application. This gateway application may also act as a personal cloud/locker service, providing access to the individual’s media and content, as well as enabling them to control their privacy settings. In other words, ultimately, consumers may want an assistant or agent that amalgamates the personalised discovery services offered by apps, such as Google Now, online media services, such as iCloud, and the traditional functions of a wallet, such as payments, receipts, coupons and loyalty programmes.

Business model battles

The Brainstorm confirmed that the digital commerce market continues to be held back by the slow and familiar dance between the established interests of banks/payment networks, telcos, and retailers. Designing business models that sufficiently incentivise each partner is tough: big retailers, for example, are likely to resist digital commerce solutions that don’t address their dissatisfaction about transaction fees – there was some excitement about digital commerce solutions that workaround the major payment networks’ interchange systems.

Some of the participants in the Brainstorm held strongly entrenched views about which players can contribute to growth in digital commerce and should therefore benefit most from that growth. The arguments boiled down to:

  • The banking ecosystem believes it is well placed because of the requirement for transactions to be processed by entities with banking licenses and that comply with know your customer (KYC) regulations.
  • Telcos believe that, as digital commerce-related data travels over their networks, they will understand the market better than other players.
  • Retailers believe that they have the customer relationships and that digital commerce offers opportunities to strengthen those relationships and reduce the costs of transactions.

The length and complexity of the digital commerce value chain raises significant questions about whether one entity could and should own the customer relationship and manage customer care across the whole experience. Moreover, there may be a disconnect between elements of the value chain and the overall value proposition. For example, individual retailers may wish to offer fully-customised digital commerce experiences delivered through their own branded apps, but consumers may not want to see the complexity of the existing marketplace, in which they are asked to register and carry multiple loyalty cards, continue in an increasingly digitised world.

While the traditional players jostle for the best positions in the value chain, the door is wide open for market entrants to come with radically disruptive business models. Although telcos have the customer data to be play a pivotal role in digital commerce, other players will work around them unless telcos are prepared to move quickly and partner on equitable terms. In many cases, telcos (and other would-be digital commerce) brokers may have to compromise on margins to seed the market and ultimately gain scale – small merchants (the long tail), which have highly inefficient marketing today, have a greater incentive than large retailers to adopt such solutions. Participants in the Silicon Valley Brainstorm thought that either established Internet players or a start up would ultimately win over the banks and telcos in local commerce.

Who is best placed to win in local commerce April 2013

Consumers are most likely to adopt digital commerce services that offer convenience and breadth. Therefore, such services need to act as open and flexible brokers, which enable a wide range of merchants to use application programming interfaces (APIs) to plug in vouchers and loyalty schemes quickly and easily.

Mobile advertising – still very immature

Immature and messy, the mobile advertising market is still a long way from being as structured as, for instance, television advertising, in terms of standardising metrics for buyers and creating an efficient procurement process. The Brainstorm highlighted the profusion of different technologies and platforms that is making the mobile advertising market highly-fragmented and very resource-intensive for media buyers. In many cases, the advertising industry may be struggling to differentiate between mobile networks, mobile users and mobile devices. For example, a consumer using a tablet on a sofa may be seeing the same adverts as a smartphone user travelling to work on a train.

In essence, the creatives working in advertising agencies are not certain what messages and formats work on a mobile screen, as buyers don’t have reliable ROI data and the advertising networks continue to struggle to deliver precise targeting, stymied by multiple barriers, such as privacy fears, walled gardens and bandwidth constraints. As a result, there is widespread dissatisfaction among both media buyers and consumers with mobile advertising. The mobile advertising market needs robust tools and processes – standardised, proven formats and reliable, trusted metrics – to will enable brands to purchase advertising at scale and with confidence.

Some media buyers are looking for solutions that make the delivery of digital advertising more transparent to consumers, so they have a clearer understanding of why they are seeing a particular advert.

To address these issues, telcos, looking to broker advertising, need to create better platforms that are easy for media buyers to access, offer precise targeting and provide transparent metrics that are straightforward to monitor. Despite the formation of telco marketing and advertising joint ventures in some markets, such as the U.K., some advertising executives believe telcos don’t see a big enough revenue opportunity to build these platforms.

Instead of brand building and customer acquisition, which is the traditional use of mass advertising, it seems likely that the mobile channel will be used primarily for customer loyalty and retention. So-called active advertising (advertising that is designed to enable the individual to complete a specific task) may be well suited to mobile devices, which people typically use to get something done. As attention spans are short and screen space is limited in the mobile medium, the advertising value chain will need to change its mindset to put the needs of the consumer, rather than the brand, front and centre.

Big data – how to monetize?

The Brainstorm reinforced the sense that big data/personal data has the potential to create exceptional insights and disruptive new business models. But most people working in this space only have a high-level, theoretical view of how this might happen, rather than a collection of compelling case studies and use cases. Finding big data projects offering a respectable return on investment is going to be a hit and miss affair, requiring an open mind and the patience to experiment.

Although self-authenticated data could potentially make advertising and marketing more efficient, it may also increase transparency for consumers: The Internet has given consumers more control and is driving deflation in many sectors. The rise of personal data could have negative implications for companies’ profit margins as consumers use vendor relationship management systems to systematically secure the best price.

Many start-ups seem to still be pursuing advertising-funded business models, but big data and personal data business models may depend on a different approach. They should be asking: “How do you fund a search engine that is not ad-funded and can social networks not be ad-funded?” Computational contracts, which machines can execute and people can actually understand, could be part of the answer. Rather than trying to infer interests and movements, a social network might explicitly ask the following question. “If you give me your location and the brands you like, I’ll give you two coupons a day.” This is basically the Placecast model, which seems to be gaining traction in some markets. In any case, telcos and banks could and should use transparent and user-friendly privacy policies as a competitive weapon against Facebook and Google, which currently dominate the online advertising market.

The concept of companies interacting with individuals through the web presence of their objects, such as their car, their bike or their pet, seems sound. Both individuals and companies could benefit from a two-way flow of information around these objects. For example, a consumer with a specific make of printer or camera could benefit from personalised and timely discounts on accessories, such as cartridges and lenses.

Next steps for STL Partners

We will:

  • Continue to research and explore ‘Digital Commerce’ at our Executive Brainstorms, with particular emphasis on practical steps to create the Digital Wallet, enable ‘SoMoLo’, and the key role of personal data and trust frameworks;
  • Look further into the needs and applications of ‘Big Data’ into the field, as well as continuing our involvement in the World Economic Forum’s (WEF) work on Trust Networks for personal data;
  • Publish further research on the business case for personal data, and a full Strategy Report on the Digital Commerce area.


To read the note in full, including the following sections detailing additional analysis…

  • Closing the loop between advertising and payments
  • First stimulus presentation
  • Second stimulus presentation
  • Innovation showcase
  • Brainstorm
  • Key takeaways
  • Advertising & Marketing: Radical Game Change Ahead
  • First and Second stimulus presentations
  • Final stimulus presentation
  • Brainstorm
  • Key takeaways
  • Session 3: Big Data – Exploiting the New Oil for the New Economy
  • Stimulus Speakers and Panellists
  • Stimulus presentations
  • Voting, feedback, discussions
  • Key takeaways

…and the following figures…

  • Figure 1 – Customer Data is at the centre of Digital Commerce
  • Figure 2 – What will North American consumers value most from digital commerce?
  • Figure 3- Leading players’ strengths and weaknesses upstream and downstream
  • Figure 4 – The key elements of the digital commerce flywheel
  • Figure 5 – Vast majority of commerce is still offline
  • Figure 6 – Linking location-based offers to payment cards
  • Figure 7 – Participants’ views on likely winners in ‘local’ digital commerce
  • Figure 8 – Mobile ad spend doesn’t reflect the time people spend in this medium
  • Figure 9 – What does the advertising industry need to do to stay relevant?
  • Figure 10 – Why personal data isn’t like oil
  • Figure 11 – A strawman process for personal data
  • Figure 12 – A decentralised architecture for the Internet of My Things
  • Figure 13 – Kynetx: companies can connect through ‘things’

Members of the Telco 2.0 Executive Briefing Subscription Service and the Dealing with Disruption Stream can download the full 35 page report in PDF format here. Non-Members, please subscribe here. Digital Commerce strategies and the findings of this report will also be explored in depth at the EMEA Executive Brainstorm in London, 5-6 June, 2013. For this or any other enquiries, please email contact@telco2.net / call +44 (0) 207 247 5003.

Background & Further Information

Produced and facilitated by business innovation firm STL Partners, the Silicon Valley 2013 event brought together 150 specially-invited senior executives from across the communications, media, retail, banking and technology sectors, including:

  • Apigee, Arete Research, AT&T,ATG, Bain & Co, Beecham Research, Blend Digital Group, Bloomberg, Blumberg Capital, BMW, Brandforce, Buongiorno, Cablelabs, CenturyLink, Cisco, CITI Group, Concours Ventures, Cordys, Cox Communications, Cox Mobile, CSG International, Cycle Gear, Discovery, DoSomething.Org, Electronic Transactions Association, EMC Corporation, Epic, Ericsson, Experian, Fraun Hofer USA, GE, GI Partners, Group M, GSMA, Hawaiian Telecom, Huge Inc, IBM, ILS Technology, IMI Mobile Europe, Insight Enterprises, Intel, Ketchum Digital, Kore Telematics, Kynetx, MADE Holdings, MAGNA Global, Merchant Advisory Group, Message Systems, Microsoft, Milestone Group, Mimecast, MIT Media Lab, Motorola, MTV, Nagra, Nokia, Oracle, Orange, Panasonic, Placecast, Qualcomm, Rainmaker Capital, ReinCloud, Reputation.com, SalesForce, Samsung, SAP, Sasktel, Searls Group, Sesame Communications, SK Telecom Americas, Sprint, Steadfast Financial, STL Partners/Telco 2.0, SystemicLogic Ltd., Telephone & Data Systems, Telus, The Weather Channel, TheFind Inc, T-Mobile USA, Trujillo Group LLC, UnboundID, University of California Davis, US Cellular Corp, USC Entertainment Technology Center, Verizon, Virtustream, Visa, Vodafone, Wavefront, WindRiver, Xtreme Labs.

Around 40 of these executives participated in the ‘Digital Commerce’ session.

The Brainstorm used STL’s unique ‘Mindshare’ interactive format, including cutting-edge new research, case studies, use cases and a showcase of innovators, structured small group discussion on round-tables, panel debates and instant voting using on-site collaborative technology.

We’d like to thank the sponsors of the Brainstorm:
Silicon Valley 2013 Sponsors

Strategy 2.0: Google’s Strategic Identity Crisis

Summary: Google’s shares have made little headway recently despite its dominance in search and advertising, and it faces increasing regulatory threats in this area. It either needs to find new sources of value growth or start paying out dividends, like Microsoft, Apple (or indeed, a telco). Overall, this is resulting in something of a strategic identity crisis. A review of Google’s strategy and implications for Telcos. (March 2012, Executive Briefing Service, Dealing with Disruption Stream).

Google's Advertising Revenues Cascade

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Below is an extract from this 24 page Telco 2.0 Report that can be downloaded in full in PDF format by members of the Telco 2.0 Executive Briefing service and the Telco 2.0 Dealing with Disruption Stream here. Non-members can subscribe here, buy a Single User license for this report online here for £595 (+VAT for UK buyers), or for multi-user licenses or other enquiries, please email contact@telco2.net / call +44 (0) 207 247 5003. We’ll also be discussing our findings and more on Google at the Silicon Valley (27-28 March) and London (12-13 June) New Digital Economics Brainstorms.

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Executive Summary

Google appears to be suffering from a strategic identity crisis. It is the giant of search advertising but it also now owns a handset maker, fibre projects, an increasingly fragmented mobile operating system, a social network of questionable success, and a driverless car programme (among other things). It has a great reputation for innovation and creativity, but risks losing direction and value by trying to focus on too many strategies and initiatives.

We believe that Google needs to stop trying to copy what Apple and Facebook are doing, de-prioritise its ‘Hail Mary’ hunt for a strategy (e.g. driverless cars), and continue to build new solutions that serve better the customers who are already willing to pay – namely, advertisers.

It is our view that the companies who have created most value in the market have done so by solving a customer problem really well. Apple’s recent success derives from creating a simpler and more beautiful way (platform + products) for people to manage their digital lives. People pay because it’s appealing and it works.

Google initially solved how people could find relevant information online and then, critically, how to use this to help advertisers get more customers. They do this so well that Google’s $37bn revenues continue to grow at double digit pace, and there’s plenty of headroom in the market for now. While the TV strategy may not yet be paying off, it would seem sensible to keep working at it to try to keep extending the reach of Google’s platform. 

While Android keeps Google in the mobile game to a degree, and has certainly helped to constrain certain rivals, we think Google should cast a hard eye over its other competing and distracting activities: Motorola, Payments, Google +, Driverless Cars etc. Its management team should look at the size of the opportunity, the strength of the competition, and their ability to execute in each. 

Pruning the projects might also lose Google an adversary or two, and it might also afford some reward to shareholders too. After all, even Apple has recently decided to pay back some cash to investors.

This may be very difficult for Google’s current leadership. Larry Page seems to have the restless instincts of the stereotypical Valley venture capitalist, hunting the latest ideas, and constantly trying to create the next big beautiful thing. The trouble is that this is Google in 2012, not 1995, and it looks to us at least that a degree of ‘sticking to the knitting’ within Google’s huge, profitable and growing search advertising business may be a better bet than the highly speculative (and expensive) ‘Hail Mary’ strategy route. 

This may sound surprising coming from us, the inveterate fans of innovation at Telco 2.0, so we’d like to point out some important differences between the situations that Google and the telcos are in:

  • Google’s core markets are growing, not flat or shrinking, and are at a different life-stage to the telecoms market;
  • Google is global, rather than being confined to any given geography. There are many opportunities still out there.
  • We are not saying that Google should stop innovating, but we are saying it should focus its innovative energy more clearly on activities that grow the core business.

Introduction

In January this year, Google achieved a first – it missed the consensus forecast for its quarterly earnings. There is of course no magic in the consensus, which is an average of highly conventionalised guesses from a bunch of City analysts, but it is as good a moment as ever to review Google’s strategic position. If you bought Google stock at the beginning, you may not need to read this, as you’re probably very rich (the return since then is of the order of 400%). The entirety of this return, however, is accounted for by the 2004-2007 bull run. On a five-year basis, Google stock is ahead 30%, which sounds pretty impressive (a 6% annual return), but again, all the growth is accounted for by the last surge upwards over the summer of 2007. The peak was achieved on the 2nd of November, 2007. 

As this chart shows, Google stock is still down about 9% from the peak, and perhaps more importantly, its path tracks Microsoft very closely indeed. Plus Microsoft investors get a dividend, whereas Google investors do not.

Figure 1: Google, Microsoft 2.0?

Google, Microsoft 2.0?
Source: Google Finance

Larry Page is reported to have said that “Google is no longer a “search company.” He says its model is now 

“invent wild things that will help humanity, get them adopted by users, profit, and then use the corporate structure to keep inventing new things.”

No longer a search company? Take a look at the revenues. Out of Google’s $37.9bn in revenues in 2011, $36bn came from advertising, aka the flip side of Google Search. Despite a whole string of mammoth product launches since 2007, Google’s business is essentially what it was in 2007 – a massive search-based advertising machine.

Google’s Challenges

Our last Google coverage – Android: An Anti-Apple Virus ? and the Dealing with the Disruptors Strategy Report   suggested that the search giant was suffering from a lack of direction, although some of this was accounted for by a deliberate policy of experimenting and shutting down failed initiatives.

Since then, Google has launched Google +, closed Google Buzz, and closed Google Wave while releasing it into a second life as an open-source project. It has been involved in major litigation over patents and in regulatory inquiries. It has seen an enormous boom in Android shipments but not necessarily much revenue. It is about to become a major hardware manufacturer by acquiring Motorola. And it has embarked on extensive changes to the core search product and to company-wide UI design.

In this note, we will explore Google’s activities since our last note, summarise key threats to the business and strategies to counter them, and consider if a bearish view of the company is appropriate.

We’ve found it convenient to organise Google’s business  into several themed groups as follows:

1: Questionable Victories

Pyrrhic victory is defined as a victory so costly it is indistinguishable from defeat. Although there is nothing so bad at Google, it seems to have a knack of creating products that are hugely successful without necessarily generating cash. Android is exhibit A. 

The obvious point here is surging, soaring growth – forecasts for Android shipments have repeatedly been made, beaten on the upside, adjusted upwards, and then beaten again. Android has hugely expanded the market for smartphones overall, caused seismic change in the vendor industry, and triggered an intellectual property war. It has found its way into an awe-inspiring variety of devices and device classes.

But questions are still hanging over how much actual money is involved. During the Q4 results call, a figure for “mobile” revenues of $2.5bn was quoted. This turns out to consist of advertising served to browsers that present a mobile device user-agent string. However, Google lawyer Susan Creighton is on record as saying  that 66% of Google mobile web traffic originates from Apple iOS devices. It is hard to see how this can be accounted for as Android revenue.

Further, the much-trailed “fragmentation” began in 2011 with a vengeance. “Forkdroids”, devices using an operating system based on Android but extensively adapted (“forked” from the main development line), appeared in China and elsewhere. Amazon’s Kindle Fire tablet is an example closer to home.

And the intellectual property fights with Oracle, Apple, and others are a constant source of disruption and a potentially sizable leakage of revenue. In so far as Google’s motivation in acquiring Motorola Mobility was to get hold of its patent portfolio, this has already involved very large sums of money. Another counter-strategy is the partnership with Intel and Lenovo to produce x86-based Android devices, which cannot be cheap either and will probably mean even more fragmentation.

This is not the only example, though – think of Google Books, an extremely expensive product which caused a great deal of litigation, eventually got its way (although not all the issues are resolved), and is now an excellent free tool for searching in old books but no kind of profit centre. Further, Google’s patented automatic scanning has the unfortunate feature of pulling in marginalia, etc. from the original text that its rivals (such as Amazon Kindle) don’t.
Further, Google has recently been trying to monetise one of its classic products, the Google Maps API that essentially started the Web 2.0 phenomenon, with the result that several heavy users (notably Apple and Foursquare)  have migrated to the free OpenStreetMap project and its OpenLayers API.

2: Telco-isation

Like a telco, Google is dependent on one key source of revenue that cross-subsidises the rest of the company – search-based advertising. 

Figure 2: Google’s advertising revenues cascade into all other divisions

Google's Advertising Revenues Cascade

[NB TAC = Traffic Acquisition Cost, CoNR = Cost of Net Revenues]

Having proven to be a category killer for search and advertising across the  whole of the Internet, the twins (search and ads) are hugely critical for Google and also for millions of web sites, content creators, and applications developers. As a result, just like a telco, they are increasingly subject to regulation and political risk. 

Google search rankings have always been subject to an arms race between the black art of search-engine optimisation and Google engineers’ efforts to ensure the integrity of their results, but the whole issue has taken a more serious twist with the arrival of a Federal Trade Commission inquiry into Google’s business practices. The potential problems were dramatised by the so-called “white lady from Google”  incident at Google Kenya, where Google employees scraped a rival directory website’s customers and cold-called them, misrepresenting their competitors’ services, and further by the $500 million online pharmacy settlement. Similarly, the case of the Spanish camp site that wants to be disassociated from horrific photographs of a disaster demonstrates both that there is a demand for regulation and that sooner or later, a regulator or legislator will be tempted to supply it.

The decision to stream Google search quality meetings online should be seen in this light, as an effort to cover this political flank.

As well as the FTC, there is also substantial regulatory risk in the EU. The European Commission, in giving permission for the Motorola acquisition, also stated that it would consider further transactions involving Google and Motorola’s intellectual property on a case-by-case basis. To put it another way, after the Motorola deal, the Commission has set up a Google Alert for M&A activity involving Google.

3: Look & Feel Problems

Google is in the process of a far-reaching refresh of its user interfaces, graphic design, and core search product. The new look affects Search, GMail, and Google + so far, but is presumably going to roll out across the entire company. At the same time, they have begun to integrate Google + content into the search results.

This is, unsurprisingly, controversial and has attracted much criticism, so far only from the early adopter crowd. There is a need for real data to evaluate it. However, there are some reasons to think that Search is looking in the wrong place.

Since the major release codenamed Caffeine in 2008, Google Search engineers have been optimising the system for speed and for first-hit relevance, while also indexing rapidly-changing content faster by redesigning the process of “spidering” web sites to work in parallel. Since then, Google Instant has further concentrated on speed to the first result. In the Q4 results, it was suggested that mobile users are less valuable to Google than desktop ones. One reason for this may be that “obvious” search – Wikipedia in the first two hits – is well served by mobile apps. Some users find that Google’s “deep web” search has suffered.

Under “Google and your world”, recommendations drawn from Google + are being injected into search results. This is especially controversial for a mixture of privacy and user-experience reasons. Danny Sullivan’s SearchEngineLand, for example, argues that it harms relevance without adding enough private results to be of value. Further, doubt has been cast on Google’s numbers regarding the new policy of integrating Google accounts into G+ and G+ content into search.

Another, cogent criticism is that it introduces an element of personality that will render regulatory issues more troublesome. When Google’s results were visibly the output of an algorithm, it was easier for Google to claim that they were the work of impartial machines. If they are given agency and associated with individuals, it may be harder to deny that there is an element of editorial judgment and hence the possibility of bias involved.

Social search has been repeatedly mooted since the mid-2000s as the next-big-thing, but it seems hard to implement. Yahoo!, Facebook, and several others have tried and failed.

Figure 3: Google + on Google Trends: fading into the noise?

 Google + on Google Trends: Fading Into the Noise?
Source: Google Trends

It is possible that Google may have a structural weakness in design as opposed to engineering (which is as excellent as ever). This may explain why a succession of design-focused initiatives have failed – Wave and Buzz have been shut down, Google TV hasn’t gained traction (there are less than one million active devices), and feedback on the developer APIs is poor.

4: Palpable Project Proliferation

Google’s tendency to launch new products is as intimidating as ever. However, there is a strong argument that its tireless creativity lacks focus, and the hit-rate is worrying low. Does Google really need two cut-down OSs for ultra-mobile devices? It has both Android, and ChromeOS, and if the first was intended for mobile phones and the second for netbooks, you can now buy a netbook-like (but rather more powerful) Asus PC that runs Android. Further, Google supports a third operating system for its own internal purposes – the highly customised version of Linux that powers the Google Platform – and could be said to support a fourth, as it pays the Mozilla Foundation substantial amounts of money under the terms of their distribution agreement and their Boot to Gecko project is essentially a mobile OS. IBM also supported four operating systems at its historic peak in the 1980s.  

Also, does Google really need to operate an FTTH network, or own a smartphone vendor? The Larry Page quote we opened with tends to suggest that Google’s historical tendency to do experiments is at work, but both Google’s revenue raisers (Ads and YouTube, which from an economic point of view is part of the advertising business) date from the first three years as a public company. The only real hit Google has had for some time is Android, and as we have seen, it’s not clear that it makes serious money.

Google Wallet, for example, was launched with a blaze of publicity, but failed to attract support from either the financial or the telecoms industry, rather like its predecessor Google Checkout. It also failed to gain user adoption, but it has this in common with all NFC-based payments initiatives. Recently, a major security bug was discovered, and key staff have been leaving steadily, including the head of consumer payments. Another shutdown is probably on the cards. 

Meanwhile, a whole range of minor applications have been shuttered

Another heavily hyped project which does not seem to be gaining traction is the Chromebook, the hardware-as-a-service IT offering aimed at enterprises. This has been criticised on the basis that its $28/seat/month pricing is actually rather high. Over a typical 3 year depreciation cycle for IT equipment, it’s on a par with Apple laptops, and has the restriction that all the applications must work in a Web browser on netbook-class hardware. Google management has been promoting small contract wins in US school districts . Meanwhile, it is frequently observed that Google’s own PC fleet consists mostly of Apple hardware. If Google won’t use them itself, why should any other enterprise IT shop do so? The Google Search meeting linked above contains 2 Lenovo ThinkPads and 13 Apple MacBooks of various models and zero Chromebooks, while none other than Eric Schmidt used a Mac for his MWC 2012 keynote. Traditionally, Google insisted on “dogfooding” its products by using them internally.

The Google Fibre project in Kansas City, for its part, has been struggling with regulatory problems related to its access to city-owned civil infrastructure. Kansas City’s utility poles have reserved areas for different services, for example telecoms and electrical power. Google was given the concession to string the fibre in the more spacious electrical section – however, this requires high voltage electricians rather than telecoms installers to do the job and costs substantially more. Google has been trying to change the terms, and use the telecoms section, but (unsurprisingly) local cable and Bell operators are objecting. As with the muni-WLAN projects of the mid-2000s, the abortive attempt to market the Nexus One without the carriers, and Google Voice, Google has had to learn the hard way that telecoms is difficult.

And while all this has been going on, you might wonder where Google Enterprise 2.0 or Google Ads 2.0 are.

5. Google Play – a Collection of Challenges?

Google recently announced its “new ecosystem”, Google Play. This consists of what was historically known as the Android Market, plus Google Books, Google Music, and the web-based elements of Google Wallet (aka Google Checkout). All of these products are more or less challenged. Although the Android Market has been a success in distributing apps to the growing fleets of Android devices, it continues to contain an unusually high percentage of free apps, developer payouts tend to be lower than on its rivals, and it has had repeated problems with malware. Google Books has been an expensive hobby, involving substantial engineering work and litigation, and seems unlikely to be a profit centre. Google Music – as opposed to YouTube – is also no great success, and it is worth asking why both projects continue.

However, it will be the existing manager of Google Music who takes charge, with Android Market management moving out. It is worth noting that in fact there were two heads of the Android Market – Eric Chu for developer relations and David Conway for product management. This is not ideal in itself.

Further, an effort is being made to force app developers to use the ex-Google Checkout system for in-app billing. This obviously reflects an increased concern for monetisation, but it also suggests a degree of “arguing with the customers”.

To read the note in full, including the following additional analysis…

  • On the Other Hand…
  • Strengths of the Core Business
  • “Apple vs. Google”
  • Content acquisition
  • Summary Key Product Review
  • Search & Advertising
  • YouTube and Google TV
  • Communications Products
  • Android
  • Enterprise
  • Developer Products
  • Summary: Google Dashboard
  • Conclusion
  • Recommendations for Operators
  • The Telco 2.0™ Initiative
  • Index

…and the following figures…

  • Figure 1: Google, Microsoft 2.0?
  • Figure 2: Google’s advertising revenues cascade into all other divisions
  • Figure 3: Google + on Google Trends: fading into the noise?
  • Figure 4: Google’s Diverse Advertiser Base
  • Figure 5: Google’s Content Acquisition. 2008-2009, the missing data point
  • Figure 6: Google Product Dashboard

Members of the Telco 2.0 Executive Briefing Subscription Service and the Telco 2.0 Dealing with Disruption Stream can download the full 24 page report in PDF format hereNon-Members, please subscribe here, buy a Single User license for this report online here for £595 (+VAT for UK buyers), or for multi-user licenses or other enquiries, please email contact@telco2.net / call +44 (0) 207 247 5003.

Organisations, geographies, people and products referenced: AdSense, AdWords, Amazon, Android, Apple, Asus, AT&T, Australia, BBVA, Bell Labs, Boot to Gecko, Caffeine, CES, China, Chromebook, ChromeOS, ContentID, David Conway, Eric Chu, Eric Schmidt, European Commission, Facebook, Federal Trade Commission, GMail, Google, Google +, Google Books, Google Buzz, Google Checkout, Google Maps, Google Music, Google Play, Google TV, Google Voice, Google Wave, GSM, IBM, Intel, Kenya, Keyhole Software, Kindle Fire, Larry Page, Lenovo, Linux, MacBooks, Microsoft, Motorola, Mozilla Foundation, Netflix, Nexus, Office 365, OneNet, OpenLayers API, OpenStreetMap, Oracle, Susan Creighton, ThinkPads, VMWare, Vodafone, Western Electric, Wikipedia, Yahoo!, Your World, YouTube, Zynga

Technologies and industry terms referenced: advertisers, API, content acquisition costs, driverless car, Fibre, Forkdroids, M&A, mobile apps, muni-WLAN, NFC, Search, smart TV, spectrum, UI, VoIP, Wallet

Google’s Complex Execution of simple Two-Sided Business Model Strategies

Strategy One: Transactions

If your business is all about facilitating transactions, as two-sided businesses frequently are, then an obvious way to make money is to work on commission – to charge a percentage of each deal for your services. This is of course the traditional way of remunerating people whose jobs consist of buying and selling – salesmen , stockbrokers, investment bankers. It sets up incentives to maximise the number of deals and secondly to maximise their value.

Amazon’s merchant pricing is simple enough – when a sale is made, it takes a percentage. But the interesting element in this is that it maximises the number of sales by giving away all its services up to the point of sale. It costs nothing to list your products on Amazon.com – it also costs nothing to carry Amazon products on your own e-commerce site. It costs nothing to use their superb analytics tools to understand your customers. It costs nothing to use their payments system. It costs nothing to ship through Amazon’s forward and reverse logistics…until you actually make a sale, collect the cash, and ship out the goods. There is also no upfront cost for the use of their superlative IT infrastructure – S3, SQS, and EC2 users pay for the capacity they use.

Similarly, the global credit-card network VISA works on commission. It receives revenue from two sources – fees paid by merchants for service, and a percentage transaction charge. The interesting element is that much of the money taken in transaction fees is redistributed through VISA’s internal economy to the banks involved in that transaction, essentially subsidising both the issue and acceptance of credit cards and therefore maximising the volume of transactions. Rather than paying a fee for a credit card, you pay for it in transaction fees, a cost you share with the merchants, who are therefore sharing the incremental revenue from credit card customers with VISA.

Strategy One can be summed up as free entry and transaction charging.

Strategy Two: Bar Takings

Lloyds of London started out as a cafe; everyone knows that. It became an insurance market because a lot of marine insurance brokers went there for their coffee, and stayed for the rumours. Eventually some bright spark realised that if you wanted to buy the rumour and sell the fact, it helped to be close enough to the source of the rumours (and, good heavens, perhaps even the facts) to trade immediately.

But Lloyds Coffee House was still a coffee house. It didn’t make its money by participating in the insurance market; it didn’t levy a percentage commission. It made its money by selling coffee. The more brokers turned up, and the more they spent their time working from the coffee house, the more coffee they sold, and presumably the higher the volatility index rose, what with all the caffeine. Which created opportunities for cooler heads, and any proto-Michael Spencer who planned to run a matched book and make money on volume, running their own little Strategy One business.

Essentially, you’re creating a big pool of customers to sell things to; it doesn’t matter what they actually come to do, and in fact the reality of this may get quite a long way from the original intent. Lloyd didn’t go into business to start a marine insurance market, after all. Perhaps the canonical example of this is London itself; the City originally came there because of the ships, but by the time the port moved downriver and containerisation led to the triumph of Rotterdam, there were plenty of people doing business there for entirely different reasons.

This is also the case of those container ports – businesses spring up in their duty free zones, providing crewing, provisioning, freight forwarding, ship repair and many other services to the passing ships.

Another example of this phenomenon is the way in which the owner of major British airports, BAA plc, has progressively become a company dominated by retailers; its Strategy One landing fees are state-regulated because of its natural monopoly at Heathrow, so it put more and more effort into selling things to passengers waiting for their flights. But this is a slightly different strategy…

Strategy Three: Access

If you’ve accumulated a pool of customers by subsidising one side of the business, you’re in a position to sell them something. Therefore you’re also in a position to sell the opportunity to do business with them to others. Alternatively you can charge the customers for the opportunity to take part; £20 to get in, shut up and dance. Which one you choose depends on the crucial question – where is the scarcity?

To begin with, credit cards were scarce, and therefore merchants were uninterested. VISA arranged things so that the banks benefited from cutting the price of credit cards, and merchants were suddenly under pressure to join in. Lloyds’ 18th-century marine insurers would no doubt have found somewhere to meet up, but without the coffee house they would have had to do so uncaffeinated.

Selling Web ads as if they were billboards has important restrictions – the chance of a sale from any given display ad is low, so advertisers need to buy a large volume. The price of an individual ad is also high because of limitations on display ad inventory. The costs (monetary and non-monetary) of building a reasonable Web site continue to restrict the available inventory and keep prices up. So, all in all, web advertising remains an expensive business for most companies.

Google reverses the logic of display ads (that advertising opportunities are scarce, expensive, and risky) by forcing down the marginal cost of an advert on one side, and by subsidising the creation of ad space on the other. Blogger blogs, Google Maps, Gmail, Google Search are free and so very popular and all create both ad opportunities to sell, and more information to refine the ad-matching process. Contextual advertising, and mass production IT, expand the volume of possible buyers. Google also subsidises the creation of content to advertise against with actual cash payments through its affiliate program and through wholesale deals with major content sources.

The power of combinations

Like all the best ideas, the basic strategies offer much scope for innovation by combining them. Google is trying to build up businesses that generate subscription-like revenues, mostly through Google Apps for Business, and it may respond to the economic crisis by flipping its model and devoting more effort to the buy-side. At the moment, Google’s revenue-earning services are all marketed to upstream customers – the sell side. What could they achieve on the buy side, in terms of Vendor Relationship Management?

The great container ports combine charging for transactions (port fees), charging upstreams for access (businesses in their free zones pay rent), and selling to the crowd (providing services for passing ships).

Two-sided success for telcos will require a similar integrated strategy. Success will not come from a simplistic strategy which involves subsidies on one side and revenues on the other: a successful Telco platform will have a web, or ecosystem, of commercial relationships underpinned by complex business models and pricing strategies. A chart from our strategy report, The Two-Sided Telecoms Market Opportunity, illustrates this point:

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