Retailers' Hobson's choice: crushed by Amazon or exploited by Google

It’s no secret that during the e-commerce era, the local (and even chain) retailer has lost its hold over local customers — particularly in the face of an ever-expanding variety of online merchandise, first from Amazon and later from the clicks-and-mortar chain retailers such as Target and Wal-Mart.

Meanwhile, the tyranny of the local newspaper has been replaced by the tyranny of the search engines (i.e. Google) in controlling the ability of retailers to get their message to potential customers.

Now the Wall Street Journal reports that retailers are facing a Hobson’s choice of being exploited by Google to avoid being crushed by Amazon. (Merriam-Webster defines a Hobson‘s choice as “the necessity of accepting one of two or more equally objectionable alternatives”).

The report says that to capture more product search — advertising and purchases — Google is testing a “buy” button for its search results to reduce the number of searches that begin on Amazon:

In the third quarter, 39% of U.S. online shoppers began researching their purchases on Amazon and only 11% started on search engines like Google, according to Forrester Research . That’s a reversal from 2009, when 24% started on search engines and 18% on Amazon.
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“Amazon is increasingly running away with online retail in North America, which poses a huge problem for Google,” said Jeremy Levine, an e-commerce investor at Bessemer Venture Partners. “Google has to get in front of this and create a reasonable alternative.”

That Google chose to fight back is not surprising, nor is it surprising that it did so without consulting retailers. Given its data-driven culture, it’s also not surprising that it ran a live experiment. However, the nature of the experiment alarmed some retailers:

Retailers’ concerns about Google’s initiative were heightened in November when digital-marketing agency RKG spotted an unannounced Google test. Google users searching for “anthropologie,” the women’s clothing retailer owned by Urban Outfitters Inc., were also shown a link to a Google Shopping page with dozens of the retailer’s product ads. Anthropologie didn’t give its permission, according to a person familiar with the matter.

Or as search engine guru Larry Kim explained:

Is Google Shopping Becoming A Competitor To Retailers?

Based on this test, it would appear that's a real possibility.

Essentially, this would cut out the middleman and drive searchers to make their purchasing decisions within Google Shopping. It adds competition to what began as a branded search – rather than being presented with David Yurman rings for sale by David Yurman, the searcher sees David Yurman rings for sale at Nordstrom, Bloomingdale's and other retail sites.

If Google adopts this test as a permanent feature, it has the potential to drive up CPC's for branded search terms, as people searching for a particular type of product from a specific brand will now be presented with competitor options, as well.

Further, users can do comparison shopping right within Google Shopping, without having to go the retailers’ websites, whether they were searching for a specific retailer/brand or not. It’s another example of Google stealing traffic from your website, like they do with Knowledge Graph and vertical results like weather and flight comparisons.

This could be a welcome change for searchers; this is why Google runs all these tests. But advertisers may be annoyed to learn that searches on their brand name are being used to drive traffic to Google Shopping. … As for advertisers, I’m pretty sure they won't appreciate Google creating competition for them where it didn't exist before.

In this regard, Google is seeking revenue growth by taking traffic from those who created the content it indexed. It doesn’t have to integrate to generate the content or be able to fulfill orders, but instead can control the eyeballs (selling more ads and having more stickiness) while commoditizing retailers.

So in a fight for Total World Domination (or at least North American retail domination), Google will take away visibility and revenue from its most profitable customers.

Why does Google do this? Because it can. It’s not quite a monopoly, but it’s almost without viable competition: in the US, it has a 3:1 market share lead over its nearest competitor on PCs, and a 5:1 lead in mobile. In Europe, it has a nearly 10:1 lead, which is prompting calls for competition authorities to end its vertical integration.

The web brings a scale to retailing that never existing in the turn of the century (or Calvin Coolidge) Main Street USA era. Local retailers (and their commercial landlords) will continue to pay the price.

An end to Grove's law?

As part of my reflections on the news of SAP spending $5.8 billion to buy Sybase, I wonder whether we will finally put an end to a piece of self-serving theorizing by Stanford adjunct professor Andy Grove.

Like so much in enterprise software nowadays, the deal is big, expensive, plays to gargantuan egos and does little to increase customer value. (At least this story has one happy ending — the bailout of Sybase shareholders who finally get what the stock was worth back in 1994.)

Apparently I am not the only one questioning the business logic of the deal. The Register headlined their story “SAP buys Sybase - but why?” while the MarketWatch headline said the acquisition “draws mixed reviews.”

One possible explanation is the standard one that I give my strategy undergraduates for most multibillion dollar acquisitions: the desire of CEOs and other execs to run a bigger company. On MarketWatch, a self-identified “SAP Insider” offered a similar explanation:

SAP is simply buying revenue. Their boards technology strategy talking is so inconsistent: they praise their own in-memory DB development, then the Sybase acquisition is mainly about the mobile business while widely avoiding the DB question which is still Sybase's main business. This proves inconsistency all over the place, maybe even panic. I think that SAP as a company is not at peace with itself. They don't trust their own potential anymore. The changes in the board haven't changed anything. Maybe the problem is beyond the board.

Buying revenue is common in mature industries, where firms unable to grow their core business buy other companies so the market cap and revenue graphs show an unbroken string of increases, in an attempt to hide that the core business has simply run out of steam.

However, there is another, more substantive possibility: an end to Grove’s law, which has been offered as a maxim of IT industry strategy for almost 20 years.

Everyone knows Moore’s Law, the 1965 prediction that the number of transistors will double every 18 months (at least until we get down to atom-scale transistors.) But his successor as Intel CEO, Andy Grove, claimed a new pattern of industrial organization in the IT industry, in which horizontal monopolies of components (such as x86 microprocessors) supplanted go-it-alone vertically integrated winners such as IBM and DEC.

In our 2000 paper on PC architecture, Jason Dedrick and I cite Grove’s 1996 book Only the Paranoid Survive (esp. page 44), but other data suggests that Grove was giving speeches to this effect at Harvard b-school during the early 1990s. (As a sidelight to his day job, Grove later became a lecturer at the Stanford Graduate School of Business.)

One of the problems I had with Grove’s claim was that it was so incredibly self-serving: the same claim by (say) Carliss Baldwin would be much more credible than coming from the CEO of a company accused of monopolistic behavior in restraint of trade.

Was the Wintel duoopoly a natural outcome of economies of scale, network effects and other “increasing returns to scale” (as might be argued by Brian Arthur)? Or was it merely two lucky companies that found a window (sigh) to dominate a market niche through a combination of normal and aggressive business practices?

Whatever the explanation, the stylized world described by Grove is just about gone, as IT companies integrate up and down the stack, vertically integrate along the value chain and otherwise increasingly pursue strategies of related diversification. Microsoft, Google, Sony and Nokia are just a few examples of such strategies, as are (to a much more mundane extent) the three enterprise software giants: IBM, Oracle and SAP.

Would it be more efficient to stick with modular component specialization and interoperability, rather than gathering more and more technologies under one roof? I don’t know, but the latter strategy is what firms are doing now, rendering Grove’s law now effectively obsolete.

Len Lauer’s brave bet on open innovation

Well, everyone was telling the truth when Len Lauer stepped down as COO of Qualcomm last month to become CEO of a “non-competing” company.

He’s surfaced as the CEO of Memjet, an inkjet printer company also based in San Diego. Don Clark of the Wall Street Journal has the story.

Like Qualcomm, Memjet likes to patent things, in this case behind its lead technologist Kia Silverbrook, formerly CTO of Canon.

Something about this just doesn’t make sense. While I’m a big advocate of open innovation, Memjet is trying to crack a very vertically integrated industry.

I actually worked in inkjet printers for more than a decade — sitting there in my Oceanside software company, supervising (and sometimes actually writing) software for a wide range of color printers, including (for a time) most of HP’s inkjets.

The problem I see with Len’s career move is the part about Memjet licensing its inkjet heads to others to make the actual printers. HP, Canon and Epson have a cozy patent cartel, cross licensing and making their own printers and disposable cartridges. I don’t see any of them licensing technology, no matter how cool it is. (Attempting to invent patents — or suing for a cross-license ala Broadcom — around seems much more likely).

So maybe some of the 3rd tier players — Brother, Samsung — might be interested. Maybe even the 2nd tier players such as Lexmark and Xerox. But how are you going to get market share with these players — no matter how cool your technology — given their distribution and brand recognition are so far behind the Big Three?

Even if you did, get some of them, would the royalties ($1 per printer? $5 for a printer and a lifetime of cartridges?) be enough to pay back “hundreds and hundreds of millions” of VC investment?

Yes, I certainly see the analogy to Qualcomm’s QCT chip business, but Qualcomm got into the chip business when no one knew how to make CDMA chips and few merchant chip vendors existed for handsets (Motorola, Nokia, Ericsson, Matsushita made their own.)

Maybe I’m missing something, but to me printers are a 20-year-old mature industry, without a lot of opportunity for entry.

So my hat’s off to Len, a braver man than I. We’ll see in a few years whether he’s a smart man too.

Viva Vevo

Tuesday was the North american launch of Vevo, the music video site owned by Universal, Sony and money from Abu Dhabi Media

I find it encouraging that the record labels are taking this step. Faced with the decimation of their decades-long revenue model — the sale of tangible music discs — they are making pro-active experiments. If the plane is losing altitude, at least they’re trying to pull up rather than the controlled flight into terrain of so many other industries afraid of cannibalizaiton.

Of course, this is a very mild step — stealing back unmonetized content views from YouTube in (probably forlorn) hopes of gaining meaningful revenues. Still, if it crashes and burns, it’s better than the controlled flight into terrain that most of Hollywood is on.

It’s interesting to see what it does to YouTube, since, — as Wired notes — most of the most popular videos are music related. By my count, before Vevo launched 14 of 24 the videos with 60+ million views were owned by labels or artists.

As the LA Times notes, this is the music industry’s version of Hulu — i.e. yet another Universal anti-YouTube site. The Times is skeptical about claims made Tuesday about how revolutionary it is:

Bono's opening remarks were quoted by Billboard: "Friends, we are gathered here today to mourn the passing of the old model that was the music business."

Perhaps Bono has some inside information on what Vevo ultimately will become. In a quick summary, Vevo offers on-demand streaming of music content with advertisements. YouTube offers the same, without the ads, and more content.

I agree with the Times that the business model is suspect: it doesn’t work all that well for YouTube at monetizing, even if Vevo has less of the drek cluttering up the site (like all the fake videos.)

For now, it also doesn’t have videos from my favorite bands on WEA (or anything else from Warner Music Group.) Perhaps the record cartel has a plan for the firms to take turn swimming against the industry tide to make it seem less cartel-like.

Of course, some of this is correcting the original MTV mistake — giving away music videos as advertisements for the real content, rather than treating them as valuable in their own right. But then that horse escaped the barn nearly three decades ago.

Will the labels offer their content on reasonable terms to other online channels? Or will the other channels decide that the numbers can’t be made to work, long before the labels throw in the towel?

Inevitability of e-book success?

Bloomberg ran a story Friday focusing on the adoption of e-books in college classrooms:

As Sony Corp.’s e-book devices vie with the Kindle to win over readers, the real showdown may come later: when a shift to electronic textbooks at schools threatens to eclipse the current market for the products.
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Within five years, textbooks will be the biggest market for e-book devices, dwarfing sales to casual readers, predicts Sarah Epps, an analyst at Forrester Research Inc. in Cambridge, Massachusetts. Corning Inc., which is developing glass screens for e-readers, expects textbooks to fuel about 80 percent of demand for those components by 2019.

“Print will expire faster in the textbook world than in the trade book world,” Epps said. “The technical barriers will disappear and five years is enough for the content to catch up with demand. The potential is there.”
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“The Millennials are very comfortable reading things online in a way their parents and grandparents are not,” said San Jose State University Professor Joel West, referring to the generation born in recent decades. “We will be seeing electronic textbooks become commonplace in the next 10 years.”

I said a lot of other things when interviewed about this a few months back:

• Amazon‘s achilles heel is the proprietary mobi format against everyone else’s e-pub, but if college students are using a book viewer for 4 years and renting books for one semester, this becomes almost a non-issue.
• Moving from selling dead tree books (with printing costs and inventory risk) to renting e-books will reduce the publishers’ costs dramatically. If publishers don’t share those savings with consumers — given the student and politician outcry about textbook prices — there will be hell to pay. I suspect, however, that most will play games with planned obsolescence in hopes of keeping their margins up.
• I doubt that e-book reader is a separate category over the long term. To me, it seems obvious that the e-reader will go the way of the pocket camera and the MP3 player as a dead-end stand-alone device.

The unfortunate thing for Amazon and its Kindle lead is that it’s much easier for other publishers to attract the relatively small list of best-selling college texts than it is to attract a full range of popular books.

On the other hand, I think the textbook market could allow Amazon an opportunity to exit the reader business — as I believe it inevitably will — and focus on its core competence of distribution (presumably at that point indifferent as to format). Under this scenario, rapid growth in the textbook market could very well force a disaggregation of the market into distributors and players.

So Sony and Apple (and perhaps Nokia and Dell) will be competing on the hardware side and Amazon/B&N competing on the distribution side. Colleges generally shy away from mandating a particular vendor for other hardware, so I think “buy an e-pub reader” is more likely to catch on with college syllabi than “buy a Kindle.”

Nokia ending vertical integration?

This morning Nokia announced that it’s transferring 3G chipset technology and people to STMicro. The reports are somewhat vague — perhaps deliberately so on Nokia’s part — but it sounds like they are exiting the radio modem chipset business.

From the various accounts

• Nokia is licensing its 3G technology to ST and sending it 200 of its existing workers. That sounds like an exit to me.
• Nokia wants to have dual suppliers, and not be entirely dependent on TI for 3G chips. TI stock fell on the news.
• Nokia plans to license this technology to other firms to gain additional revenues.

On an unrelated note, Nokia is buying obsolete technologies from Broadcom (EDGE) and Infineon (GSM). Perhaps that’s a foot in the door for both firms and they will be able to provide 3G products in the future.

Once upon a time, several mobile phone companies were fully vertically integrated, providing end-to-end solutions of chips, phones and even infrastructure. Firms that notoriously used their own semiconductors were Samsung, Matsushita (Panasonic), Motorola and Nokia. (The articles also imply Ericsson but I’d never heard them mentioned). The move by Nokia — both to license out technology and procure chips from external suppliers — is a classic shift from vertical integration to open innovation, consistent with established principles of open innovation.

HSDPA is the first WCDMA technology that will actually deliver broadband speeds of 1 mbps or more, and was developed with input from Qualcomm and what it learned from developing the earlier EV-DO technology for cdma2000. I was struck by how difficult it is to make HSDPA chipsets, and thus the number of suppliers has been winnowed down tremendously from GSM.

Here are two quotes that capture this effect — classic Five Forces that I teach my strategy students. From the Dow Jones article:

Nokia on Wednesday also announced a move to license out its modem technology to chipset vendors in order to bring in additional revenue and allow new players to enter the market. The industry has traditionally had a high barrier to entry because of the complexity of the technology expertise required. Modems are the interfaces between chips and radio signals and act as the communications center of a chipset.

The Financial Times article was even more specific:

The decision to broaden its range of chipset suppliers and license proprietary technology for high-speed WCDMA/HSDPA mobile phone chips will be an opportunity for chip companies such as STMicroelectronics and Broadcom to enter a new market.

Currently, only Nokia, Ericsson Mobile Platforms and Qualcomm are believed to have technology to make cost-effective, WCDMA/HSDPA chips.

The FT exaggerates a little, in that so far only ST is getting a license to the coveted HSDPA technology. Still, under the rule of ”the enemy of my enemy is my friend,” Nokia has a natural ally in Broadcom, who’s been winning a series of patent fights with Qualcomm.

Is the scarcity of HSDPA vendors a transient issue tied to learning curves, or a permanent shrinking of the supply pool?On the one hand, GSM was once cutting edge and now has a wide range of suppliers. On the other hand, the x86 processor suppliers have certainly been winnowed down over the past 25 years. Adding to the uncertainty are all those WCDMA patents.

Technorati Tags: 3G, Nokia, open innovation, semiconductors, vertical integration

Nokia vs. Yahoo smackdown!

Yahoo bought the photo sharing service Flickr in 2005. This morning came the news that Nokia bought Twango, founded by Microsoft refugees in Redmond. Telecom blogger Om Malik calls Twang “a combo of YouTube, Flickr, Shutterfly, Photobucket and Xdrive.”

There are some odd aspects to this. #1 of course is that Nokia supports Flickr on its phones, and in fact Flickr made Nokia S60 phones the centerpiece of its ZoneTag location-aware photo sharing prototype (including a very recent update to support some S60 3rd Edition phones).

The 2nd odd thing is that Nokia is buying a content sharing service, when its biggest customers are mobile phone operators that see themselves as being in the content service business. Does this presage a broader push into consumer services — head to head with the operators as well as Internet behemoths like Google and Yahoo? I realize Nokia expects to be beholden to no one, but in Strategy 101 we teach that moving outside one’s competencies and competing with major customers are two very bad (and common) outcomes of vertical integration.

Caroline McCarthy of CNET says it best:

It's unlikely that this acquisition will affect a whole lot of people who aren't Nokia customers (and it's not yet very clear as to how Twango itself will change) but it'll be interesting to see how this affects mobile media-sharing.

Technorati Tags: diversification, Nokia, social networking, vertical integration, Yahoo

Eric Schmidt Succumbs to Temptation?

Among are many temptations facing big company CEOs are the twin lures of “related” diversification and vertical integration. Both can make economic sense, but they are often pursued for the wrong reasons. Latest rumors suggest that Google CEO Eric Schmidt is succumbing to the latter temptation.

Diversification allows a firm to reuse capabilities — whether R&D and distribution — for other products. HP found a way to make inkjet printers (and repackage laser engines) to the degree that peripheral profits (and market share) dwarf anything it does in PCs. On the other hand, IBM, the biggest computer company in the world found that its sales channel (and cost structure) couldn’t efficiently sell PCs, and so it dumped them after years of losses.

Vertical integration makes sense if you can’t buy inputs (or sell outputs) on the open market. If a company makes mobile phones, perhaps it should make the components or software that go into those phones. Apple created its own retail distribution channel because the existing one was ignoring a platform with 3% market share, but Palm tried the same thing and failed.

When Schmidt got his C.S. Ph.D. from Berkeley, as far as I know he never sat in one of Oliver Williamson’s courses about industrial organization. Maybe that explains rumors that Google is developing its own mobile phone (complete with pictures).

In web services, vertical integration is tricky. If Google starts selling its own client devices, it will be tempted to favor its own client — pissing off makers of rival products and owners of these products. Then owners of Nokia or Apple phones will find Yahoo’s mobile services more attractive than Google’s.

Of course, big company CEOs need revenue and earnings growth to prop up the stock price (and thus incentive compensation). When the core business stops growing, you need to find something else. Google can’t increase its market share in search, so it has to enter new markets.

Perhaps France will finally gain meaningful allies in its Quixotic fight against Google’s PacMan-like quest for total world domination.

Technorati Tags: Google, mobile phones, vertical integration