The Independent Market Observer

10/19/12 — The Power and Limits of the Web

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Oct 19, 2012 7:56:07 AM

and tagged Yesterday's News

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Two stories that made the front pages today illustrate both the power and the limits of technology. The first was the accidental prerelease of Google’s disappointing earnings. I was looking at my screen yesterday afternoon, watching the Nasdaq drop, and asking anyone who would listen, “What the heck is happening here?” No one knew at the time, though it became apparent an hour or so later what had happened.

For people who haven’t seen the story yet, the financial printer handling Google’s results report accidentally posted it prematurely to the SEC’s website. Although it was rapidly pulled, the damage had been done. The results were well below expectations, showing declines in profits and in the revenue growth rate. The stock tanked.

Google grew to be a behemoth of a company by exploiting the powers of network effects and of its own algorithms, and it has built a commanding market presence. Much of its effectiveness in a business sense comes from that level of scale. But just as technology built Google, it also enables its potential demise. Competitors have essentially no technological barriers to entry. Facebook is nipping at Google’s advertising revenue. Apple is locked in a feud with the company. Start-ups are attempting to build better algorithms and take it on directly.

Although the web has been wonderful for users and consumers, as well as for many companies, its wide-open nature makes it a much tougher place for companies to operate. Price transparency is absolute—which is why free services like Google thrive. Companies have to compete on service and scale—again, reasons Google has done so well.

This poses a problem in the long run. While the market grows, so can companies. Competition eats away at each slice, but as long as the pie gets bigger, all is well. When the size of the pie starts to stabilize, things get tough fast.

Do Google’s results show we are approaching an inflection point? I don’t know. I do know, however, that an inflection is inevitable at some time, and then margins will come under attack as companies focus more on taking market share from each other than on expanding the market as a whole. Google’s expansion into other areas—it launched the new Chromebook laptop today—suggests it is also planning for a stable market era.

The other major story today was the demise of the print edition of Newsweek. With a circulation of about 1.5 million, the magazine announced that it would be going fully digital at the end of the year.

Digital media has been something I have been thinking about since a local independent radio station I like, WFNX, recently went digital. It sold its location on the FM dial to a corporate chain and went exclusively to the web.

Are we there yet? Can you run a media business on a purely digital platform? In one sense, the answer has already been proven to be yes by the Huffington Post and others. In another sense, we don’t yet know. Old media seems to be slowly accommodating to the change, but because, as I stated above, digital is even more brutally competitive than the real world; there have been and will continue to be casualties.

By breaking out content and advertising, the core business model of old media is difficult to replicate in cyberspace. Content is freely transparent and available across all media on the web, making it tough to stand out. Equally, media must have a special access advantage to users to make them an attractive advertising platform. Some existing platforms—the Wall Street Journal, the Financial Times, and to a lesser extent the New York Times—have demonstrated that they can command a premium for exclusive content, and that they have a marketable audience. Others —like Newsweek—clearly do not meet that test.

At the end of the day, the power of technology in a business sense is to strip away the traditional tools of success, such as market or content exclusivity, and magnify the advantages of scale. This can enable monopolies to dominate in a way that has not been possible before, which can be a scary thing from a consumer perspective. The saving grace, however, is that technology also enables the monopolies to be overturned on a regular basis. The key to continued progress will be maintaining the ability of new companies to compete with established ones and to prevent the capture of the web by those who are currently dominant.

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