Monday, April 18, 2005

Picking the Internet Leader Using "Money Value of Time"

Among today's leading "pure play" Internet companies--Yahoo (YHOO), Google (GOOG), eBay (EBAY) and Amazon (AMZN)--which one will grow to become the largest over the next few decades?

Today these companies stack up as follows:

Company: Market Capitalization, Traffic Ranking (Source: Alexa)

Google: $51 bil., #3 in traffic
Yahoo: $45 bil., #1 in traffic
eBay: $43 bil., #5 in traffic
Amazon: $14 bil., #7 in traffic

(#2, #4 and #6 by traffic ranking are occupied by MSN, and Microsoft--all properties of Microsoft, which itself continues to gun for top spot.)

In my opinion, we are still early in the evolution of the Internet--technology, consumer habits, global usage, etc.--implying that revenues, profits and market capitalizations still have a long way to run. However, I also believe that we are far enough along, so that already very significant barriers-to-entry prevent more minor players from capturing sufficient market share to become top-tier. Since our four leaders are all profitable (Amazon became profitable in 2003) and have plenty of cash and financing available to them, they tend to make acquisitions to steer growth or to fill in areas were they are weak. These acquisitions "crowd out" other companies and keep the top-tier "oligarchy" intact.

Among the top four companies, I see a shuffle ahead over the next decade as the Internet grows and the way we use it evolves. Long term, I believe that there is a high correlation between time and money, i.e., where consumers spend their time correlates with where they spend their money. With this concept in mind, I comment on our leaders:

Google has raced into number one position by market capitalization following its IPO last fall. As search leader and "librarian of the Internet," Google has grown rapidly through selling advertising alongside search. With its high reach, high-margin business, global presence and corporate culture of innovation, Google is well-positioned to continue growing by leaps and bounds. Google has the potential to morph into a web-based on-demand software company, competing more directly with Microsoft's traditional shrink-wrapped product. However, I see a handful of weakness that could limit its growth: a) search is a "basic utility" that is not "sticky" enough--I might search using Google but I do not "hang around" on the site; b) the Google properties are not well-integrated--I use Google for search and Blogger for this blog, but I hardly know that the two are properties of the same company; and c) Google depends on a single revenue stream (advertising).

Following a revenue and profit slump in 2001 and 2002 with the dearth of online advertising spending during the dot-com fallout, Yahoo has come roaring back over the past two years. Yahoo has the broadest and most well-integrated content offerings. It has the highest traffic, widest global audience, solid profit margins and most diversified revenue sources (advertising, subscriptions, commerce). Yahoo has "sticky" content such as its Yahoo!Finance message boards, Yahoo!Groups community site, and free email. The only significant holdup I see to continuing stellar growth is its second-rate track record as an innovator--still trying to catch up to Google in search, never caught eBay in auctions (except in Japan), behind Amazon in shopping, slow to get into blogging (though finally entering with Yahoo!360, now in beta).

eBay has been the most successful in "monetizing the network effect" through its auctions, where buyers gather because that's where the sellers are, and sellers go because that's where the buyers are, ad infinitum. Early profit came from its "clean" e-commerce business of providing the transaction platform without ever touching the "dirty" garage-sale goods. The result is a high-margin business operating in a niche with a very high barrier-to-entry. Internationally, eBay has been successful in Germany and the U.K., failed in Japan (too late to start and never caught Yahoo!Auctions), bought its way into Korea, and is competing for leadership in China. eBay's primary weakness is that it does not exhibit the breadth necessary to become the "leader of the leaders" long term.

From its inception, Amazon's objective has been to become the "Wal-Mart of the web." With a market cap just 7% of Wal-Mart $200 billion, Amazon is still nowhere close to realizing this dream. The problem has been overcoming high shipping costs and a low profit margin, as Amazon has had to provide discounts to encourage more consumers to buy online. International revenue is growing but the U.S. will long remain the largest market in total consumer dollars spent. Over the years, Amazon has "built community" through hosting book, movie and product reviews. My sense is that Amazon has developed a very valuable customer-friendly franchise that has tremendous potential for monetization of its trusted brand name and reach as the way we use the Internet changes. DVD rentals, E-books and online yellow pages are areas that might bring additional revenue.

Grading the Internet leaders across the factors that matter most, we have:

Company: Breadth of Content, Depth (Stickiness), "Warmth" of User Experience (Integration, Navigation, Customer Service); International Presence, Innovation, Profit Margin

Google: B, B, B; A, A, A (overall: 3.5/4.0)
Yahoo: A, A, A; A, B, A (overall: 3.8/4.0)
eBay: C, A, B; B, B, A (overall: 3.2/4.0)
Amazon: B, B, A; B, B, C (overall: 3.0/4.0)

As I see it, in the long run, Yahoo finishes first, ahead of Google, as breadth of content, stickiness and warmth of user experience win out over innovation. Interestingly, eBay and Amazon would make a good marriage to create an e-commerce superpower, with Amazon delivering the breadth of e-commerce, and eBay the strong profit margins from its auction vertical. With this combination, I can see the pecking order becoming: Yahoo #1, Amazon-eBay #2, and Google #3. It is also possible that Google evolves to become a true competitor of Microsoft in the desktop personal utility software area, in which case Google should run ahead of Yahoo, eBay and Amazon; however, with the open-source software movement being as fragmented and decentralized as it is, I do not see Google as the clear winner here.

Since the growth of Internet companies is ultimately determined by what consumers do online, what's most important is how to monetize consumers' time. In the long run, the websites offering the best content and user experience will be where consumers spend their time and, in turn, their money. In other words, just as "time value of money" matters in traditional finance, it is "money value of time" that really counts on the Internet.

(Disclosure: I am long Yahoo, eBay and Amazon, but not Google, largely based on my policy of not buying IPOs until after one year of market "seasoning.")


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