On Monday, November 5, Google is expected to announce that it is rolling out a platform of mobile phone services as part of an “Open Handset Alliance” with various wireless hardware manufacturers and, perhaps even, a carrier or two. The move has been anticipated for months and has helped drive the company’s stock valuation to stratospheric heights (but still nowhere near the heights seen in the last tech bubble). As a result, the breathless Google boosters in the tech blogosphere are emitting even more hot air than usual, going so far as to declare that Google, a company with [“a global strategy so sweeping and audacious that it is breathtaking”], is on its way to becoming the [biggest company in history] !
While the move into mobile has some obvious business logic for Google — they are an advertising company always on the lookout for new places to stick ads — it’s not immediately obvious that their decision to go into direct competition with Microsoft in yet another space (mobile OS) and with carriers who like to control the software ecosystem of their products is such a guaranteed win for them. To figure out what might be driving their strategy I looked at Google’s 2nd quarter 10-Q SEC filings for the past four years and found some trends that suggest they have little choice about entering the mobile market, if they have any hope of maintaining the kind of momentum that investors have come to expect from them.
Revenue Growth Rate in Decline
The first thing that jumped out from an examination of their numbers is that, while income continues to increase over time as they enjoy the trend of ad dollars moving online, their year over year revenue growth rate has been trending down since 2005. This chart looks at 1st half revenue growth rate from 2003 to 2007:
It makes perfect sense that the kind of meteoric growth rates Google enjoyed in the early years of their ad business would decline over time as they came to dominate the market. What is of interest is the slower rate of decline for international versus domestic revenue. Hold that thought.
In every SEC filing I looked at Microsoft was the first item mentioned in the section on risks to their business. Going back a couple of years they began warning investors that Microsoft planned to integrate search functionality into its core operating systems and office products that could act to decrease traffic to Google web sites, where their best income derives. With the advent of Vista and Office 2007 that strategy is now in place and I don’t think it’s merely coincidental that Google domestic revenue growth declined significantly and they missed earnings expectations in the same period that Microsoft sold 85 million copies of Vista (an adoption rate twice that of XP at a similar point in its life) and in which Office 2007 had even more robust adoption. These trends will only increase as businesses begin rolling out Vista and the new Office over the next year. It looks like the free ride Google has enjoyed on a competitor’s platform is coming to an end. Hold that thought, too.
The other striking statement that I picked out of the SEC reports was that for the past 1.5 years or so the majority of traffic to Google’s web sites has been from international users. Revenue doesn’t directly correlate with traffic but this chart shows the proportion of revenue that Google collects from domestic versus international clients:
The trend is obvious: by this time next year, Google will derive a majority of its income from international sources. Given the increased income opportunity outside the United States, along with the tangible competitive threat from a resurgent Microsoft, Google’s only choice is to move even more strongly into international markets and ideally by avoiding the Microsoft platform entirely. That means mobile computing on either a neutral platform or one that they control. As [this post] from a wireless analyst explains, European mobile users are already more reliant on data services than their American counterparts — a perfect market for Google to exploit. If they can.
Reading the financial reports was enlightening in more ways than one, and acted as an antidote to the mindless boosterism found in the tech blogs. I’ve always felt that Google was a company that benefited from sleepy competitors as much as from its genius for monetizing search and exhibited a bizarre scattershot approach to finding new sources of income and decreasing its reliance on a competitor’s platform. I still think that, but at least they have a strategy in place that looks logical and just might succeed in Europe where, unlike the US, they might get help from regulators in keeping their no-longer-snoozing competitors at bay.