Wednesday, June 14, 2006

Reader Emails: Google + Innovation

A Reader Asks "You guys said Microsoft (MSFT) was going to $32 and Google was going to $650 -- what happened? "

We Reply How about a bloodbath? The market's erased all of its gains for the year, the Dow being down 11% YTD. 30% of a stock's movement (some experts think it's closer to 40%) is directly correlated to the market's overall condition, so keep that in mind.

But, we admit it: we were wrong -- in the short term. In the long term, these 2 stocks should see better days. Microsoft at 17 x is a bargain, hands down. Google, meanwhile, projects robust EPS growth through 2008 and analysts have kept their buy ratings. A few ideas related to the Google/Microsoft duel.

1. If Google cuts into MSFT's business, then Google will profit, but only in the short term. Google got where it was vis-a-vis new market disruption, a term coined by Harvard professor Clayton Christensen. New market disruption relates to firms who create business opportunities where none existed, enabling consumers to do something previously imaginable and needed, but untried. In Google's case, the need for an alternative, algorithm-based search vehicle spelled billions of dollars in sales in just 7 years.

2. By usurping or mimicking already defined technologies (spaces well defined by Softee), Google is only setting itself to fail, as me-too strategies rarely work and more often than not dilute brand personality while cannibalizing assets. Google's senior managers could learn a lot from Intel founder Andy Grove: remain paranoid and find your inflection point!

3. The Street underestimates how much Google is spending on brainpower. We wonder what kind of hours Google's HR personnel is putting in: world class engineers and seasoned execs are literally being interviewed all the time. Businesses are about the people who operate them and Google sure knows this. Intangibles like this are not reflected in Google's stock price, we believe.

4. Disruptive markets and threats require disruptive channels. Google has to find new ways to get to the end user. Acquiring neat web toys -- which they're hardly monetizing -- will only get Google so far. We understand Brin + Page are building a brand, but puh-leeeze: How much free lunch do the Palo Alto boys plan to give away? Given the fact that a whopping majority of Google's sales come from one category (adsense/advertising), the time for innovation is now.

5. Birth of a search engine: the search explosion was a prototypical disruptive force. The winner of the MSFT/GOOG feud will define growth trajectories (rather than "piggyback" on them), grab the lion's share of an early adopter category, and translate it all into mass/mainstream success. The loser will cram slightly improved technologies into existing markets, a recipe for a black eye. Just ask RCA.

In the late 50s, Sony unveiled the portable black & white TV, a truly disruptive technology. RCA, whose distribution channel/value network was in no way prepared for this new product, responded to the entrant by selling TVs that were equal or barely better than the Sony's (at appliance stores, which was not the venue of choice; people were buying TVs at discount retailers). Guess who won that one? It is very difficult for an incumbent to [re]claim territory seized by a first mover. You have to melt a customer's face (to quote comedian Jack Black) if you want to get them to move. Perchance Google is the next Sony, whose innovation run from 1955 to 1959 was truly phenomenal. Is Microsoft this decade's RCA?

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