We finally stumbled across an intelligent Google bear this week: The wise John Hussman of Hussman Funds. Hussman is one of the few active fund managers who can consistently defend his investment strategy with deep analysis and facts (as opposed to hunches, trends, common wisdom, and other hot air). Hussman’s weekly reports, which frequently torpedo the “expertise” spewed all day on CNBC et al, are invaluable.
This week, Hussman weighed in on Google. Here, unfortunately, we have to disagree with him. (Not because we think Google won’t tank–it might–but because we think he’s missing something)…
A good internet business, in my view, is one that creates a “black hole,” of what network theorists call “preferential attachment.” Some companies, particularly Amazon and Ebay, have done a remarkable job of creating hubs where buyers come because sellers are there, and sellers come because buyers are there [e.g., a network effect]. In contrast, Google is much more vulnerable to competitive entry, because the technology is well known, server farms are becoming less and less expensive, and users don’t become more likely to use Google based on what other users do. Little prevents competitors from gradually sniping market share except the slight neuromotor conditioning created by repeatedly typing the company name. I can’t stress enough that the vast majority of corporate value is determined by what is in the “tail” beyond 5-10 years. Google is essentially built on applied mathematics, and will probably have ample competition within a decade.
We agree with John’s point about the long-tail: Whatever Google is worth, the bulk of that value is based on its performance in years 10-50, not on what happens in the next few years (although the next few years will so influence investors’ perceptions of the years 10-50 that the observation is of little practical use).
Here’s where we think John is wrong:
- We think that little neuromotor conditioning (aka, habit and brand) is extremely powerful. Specifically, we think a competitor will have to produce a vast improvement in the search experience before a habitual Google user will ever consider using a different engine. Unless Google takes its eye off the ball, moreover, we think Google will be able to match competitive advances (or buy them) before the competitor can steal significant market share. The theory that “the best search doesn’t win–brands win” has been clearly demonstrated over the past few years. Ask.com has consistently been judged to have the best search experience on the web. It has advertised heavily (compared to Google’s complete lack of advertising), but, at best, its share has stayed flat. Google’s meanwhile, has soared.
- We think Google does benefit from a network effect, albeit a weak one (but no weaker than Amazon’s): Google has the most users, so Google has the most advertisers. More advertisers means more revenue which means more R&D spending. More R&D spending means sustainable competitive advantage.
Hey, Look Who’s Now the 5th Biggest US Company
Calling All Google Bears: Please Send Us Your Thoughts!
Special Bonus: Hussman on PageRank:
[Geek’s Note: Google’s PageRank is essentially the solution to a fixed-point problem x = Ax (with a little bit of “random surfing” noise added), where A is an adjacency matrix indicating which page links to which, and x is the PageRank vector. The basic idea is that the ranking of a webpage is determined by the ranking of the pages that link to it, which means that the PageRank vector is a function of itself. It’s a huge sparse-matrix eigenvector extraction, but it’s also possible to get at the solution iteratively. Stanford apparently does a good job of preparing its Ph.D. students to solve these monsters. I wrote my economics dissertation on a similar fixed point problem b = f(b) where b is a set of information processing rules of differently-informed investors and f() imposes a rational expectations equilibrium. In that context, the beliefs that investors hold are based on observing economic variables and stock prices that are, in equilibrium, driven by the beliefs that investors hold.]