4/25 Kelly Letter Topics
Weekly market review
Earnings season
SEC GS politics
Fin reform toothless
Money always talks
Greece still sinking
Japan's sliding credit
AAPL > MSFT
Falling bullishness
Grant on fin reform
Unwinding hedges
Who will buy JGBs?
Tempur-Pedic
Of snow and stocks
2010 EDITION
Much has changed; good investing has not
The Neatest Little Guide to Stock Market Investing, 2010 Edition
I've written extensively about Microsoft being threatened by the development of an internet-based operating system that would make Windows optional. My premise is that almost all applications are migrating online. When Windows is optional and non-Microsoft applications are a free download away, Microsoft will be in big trouble. Many of these articles are collected under this site's GOOG label.
Guess what? The internet OS is now available from Google. It's called Chrome and is being billed as the best browser on the market, but it's much more significant than that.
I've downloaded it and was so impressed with it as a browser that it became my default over Firefox 3 within ten minutes of test driving. That's a big testimonial because we have a rule at our office: no new apps just for the fun of it. There has to be a compelling reason to risk our perfectly functional way of getting work done to stick a toe in the notoriously risky waters of new software.
My interest in Chrome was not big. I just wanted to see how it displayed our sites, how it differed from Firefox and IE, and to generally keep on top of things for our usual ongoing research. The fact that Chrome convinced us to switch to it whole hog within ten minutes of the supposedly cursory test drive shows just how fantastic it is. Even more, though, is pondering how fantastic it will become.
We're still in the Chrome-is-a-great-browser portion of this article. I haven't forgotten the future OS angle, but it's important to understand how Google will sneak its future OS platform onto everybody's computer and then casually mention one day that it's a full-fledged OS.
Here's what converted our office from Firefox to Chrome in ten minutes:
Chrome is fast, fast, fast!
It has a clean interface that makes it easy to show/hide bookmarks and frees up a ton of screen space.
Its address bar is more awesome than the childishly named "Awesome Bar" of Firefox 3. Chrome searches any engine you want, brings up recently visited websites, and -- most impressively -- converts to a site search at places like Amazon.com.
Its handling of tabs is elegant and powerful. Drag one off the browser and it becomes a new browser window. Drag it back and it becomes a tab again. Having many tabs open does not slow things down.
The new tab page, which can be set as the home page accessible from an optional button on the address bar, shows your most visited sites in a thumbnail grid. Very helpful.
There's an "incognito window" option that keeps all activity in it private from the computer you're using. No history. No cookies. No trace of anything you did.
In case you missed this point: it's fast!
So, that's how Chrome will win the hearts of millions and earn itself the default browser slot on computers everywhere. What happens after that?
People will immediately have a much better experience with Google's own Ajax applications like Google Docs and Gmail. Why? Because Google designed a whole new Javascript engine that makes Ajax apps scream, and keeps them in steel-belted tabs so one crashing and burning takes out only its single tab instead of the whole browser. If something locks up, just close its tab.
Then, there's the ever improving Google Gears for offline access. It's so good that MySpace used it to offload much of the processing for its messaging inbox and friendslist. Previously, people had to wait for requests to be received, processed, and sent back from the server. Not now. Thanks to Gears, much of the processing happens on the user's own computer and working with MySpace is nearly as fast as working with a native desktop application.
Take Chrome with its Ajax supercharging Javascript engine, add on Gears, and you're not too far away from a full-fledged operating system. It's almost like they planned this.
People much tech savvier than I are already talking about the ease with which they can now bypass the Windows part altogether and just develop applications for the browser. That was being prepared for some time now, but the preparation is officially over.
I see you haven't bought Google yet, despite all your positive articles about it. When do you expect to buy, and will you put on your website when you actually place the order?
The Kelly Letter has owned Microsoft and Yahoo for years, and is sitting on modest profits in each. My reason for owning Microsoft was to capture upward momentum from its Windows/Office upgrade cycle that started last year; for owning Yahoo it was an eventual recovery as it streamlined and improved its competitive position against Google. I thought Yahoo was a bargain compared to Google, and didn't like Google's over-reliance on advertising for profits. Remember, some 99% of its profit is from ads.
When Google kept climbing last fall to $747 on November 7, it looked far too overpriced to me. Its MACD was over 37 and its relative strength was 86 -- both stratospheric and screaming for a correction. Part of that rally came from Jim Cramer, who in October raised his price target to $750 but called even that "a total and unequivocal lowball estimate" considering the growth potential. He said a more reasonable estimate was $900. He'll be right someday, but there was no way it was going straight there from early November's precarious peak.
So, my initial hesitation with Google was two-fold. One, I was betting on Yahoo to get itself back on track. Two, I was convinced that Google was overpriced and vulnerable to some kind of setback. I was not prescient enough to know that the market would crash as far as it did in January, nor that Google would be so punished for its slowing click rates and so on. Thus, some of the good timing was just luck (and always is, no matter what anybody tells you). However, when a stock is as out of oxygen as Google was last fall, it doesn't take much to knock it down. I knew that, and held back until something happened to it.
Then, my attitude toward Google changed. What did it was Microsoft's bid for Yahoo. To me, that marked the end of Google's serious competition online because I believe that both Google and Yahoo are working on internet-based operating systems with the potential to make Windows unnecessary, and that that's the real reason behind Microsoft's buying Yahoo. It's not actually just about advertising -- although it is somewhat, of course -- it's really about bulking up for a long war against Google for control of software-as-a-service (SaaS) computing that's going to take the world by storm any year now.
I found on SnapSheet that Google Apps's revenue has gone from $0 to $400 million in just three years. It's up ten-fold from just a year ago. Granted, $400 million is still a small figure compared with Microsoft Office's $18 billion revenue, but with its blistering rate of adoption you can be sure Google Apps won't remain a mere annoying gnat for long. Also, have you used Google Apps or Docs? I already run my business with Google Docs and, let me tell you, it's fantastic.
Furthermore, I think Microsoft's proven ineptitude online is going to destroy or at least hobble whatever chance Yahoo had against Google. Thanks to Microsoft, Yahoo is on the same path to oblivion now sporting AOL's footprints. In a few years, I think we'll see the Microsoft/Yahoo conglomerate as an online dud with a smaller share of online search than they have now, an absurdly bloated online version of Office that's outflanked in every regard by Google Apps, and an operating system from Google that's a genuine alternative to Windows.
Aside from recent events, I'm fed up with Microsoft as an investment. Steve Ballmer is no Bill Gates, at least not judging by stock performance.
Microsoft has basically been dead money for five years. Since Steve Ballmer became president in January 2000, MSFT has lost about half its value. Now, he took over at the top of the internet bubble, but even if we clip off the bear market years and just examine the stock's price from, say, the beginning of September 2003, it's still down 4%. In that same time, the S&P 500 is up 30% -- even after the recent market trouble.
Given all of the above, The Kelly Letter is looking to sell both Microsoft and Yahoo at profits, and move the proceeds into Google at a cheap price.
We've been patient with Google and are hoping that investors see the Microsoft/Yahoo merger as a big threat to Google so that the GOOG share price keeps dropping. When it gets low enough, we'll begin buying.
As always, I will tell subscribers when we place the order and at what limit price. Join us!
The most common reason cited for the difficulty of moving from local hard drive computing to online cloud computing is security. Developers think people are too afraid of storing their personal data online where it can be hacked and compromised more easily.
I think it's just a matter of time before people get comfortable with it. I remember when Amazon.com considered online security to be its greatest challenge. They used to have a "Why this is safe" link almost everywhere you went on their site. Now that millions of people have bought from Amazon.com many times and stored their financial details there with no trouble, few think of security as a reason for not shopping at Amazon.com.
Similarly, I moved my office operations to Google Docs and OpenOffice in the past year. I was hesitant at first, but now that we've used GDocs for real work from anywhere on the planet and I've seen how much easier it makes my business travels, I never think twice about whether my material is safe.
Should I? Let's test this out in the real world.
I just created and saved at Google Docs a document called "Hack Test" with a code phrase in it. I'll even give you the repository for my saved files: docs.jasonkelly.com. See if you or somebody you know can get into it and email me the code phrase. If so, we'll make big news together.
I'm betting, however, that it won't be done. I'll give a report later.
My recent articles on the Microsoft bid for Yahoo and what it means to Google have prompted numerous replies.
Visar takes exception to some of the Java comments made by a reader in Wednesday's article. Specifically, he points out that it is not possible to write one complex application in Java and have it work across all operating systems. "To be convinced," he wrote, "try and download a Java application and you will be prompted for the operating system you are going to use it on."
Actually, the Wednesday article mentioned that Java requires a virtual machine specific to each platform. That's why when you download a Java application, you must specify the operating system you'll be using it on.
That requirement doesn't take away Java's usefulness as a cross-platform development tool. Straight from Java.com comes this summary:
Mature, extremely robust, and surprisingly versatile Java technology has become invaluable in allowing developers to:
Write software on one platform and run it on practically any other platform
Create programs to run within a web browser and web services
Develop server-side applications for online forums, stores, polls, HTML forms processing, and more
Combine Java technology-based applications or services to create highly customized applications or services
Write powerful and efficient applications for mobile phones, remote processors, low-cost consumer products, and practically any device with a digital heartbeat
Next, Visar wrote:
While Java has made great headway into Enterprise Application development and solutions, Microsoft is rapidly catching up with its own multi-platform .NET Framework. I would encourage you to research recent surveys as to what the new development is going to be based on for many new development projects for all of the Fortune 500 companies. .NET is Java on steroids, it allows for multiple languages to be compiled and run into Microsoft's .NET Virtual Machine. And while Microsoft does not promote using .NET on non-Windows based platforms, there are open source movements which allow you to do so.
About Java vs. .NET, Joe Fontana at Network World wrote, "There is a lot of overlap in the capabilities of these development tools and that is the precise intersection where developers will raise their swords in religious wars. Generally, however, Microsoft's .Net is more popular in rapid-application-development environments and Java finds its way into large scale enterprise projects, but even those lines are blurring rapidly."
The main point from the perspective of business history, however, is that Microsoft saw the cross-platform ambitions of Java and Netscape as a serious enough threat to its hegemony over computing to kill the Netscape browser and create an alternative development platform, focused building applications to run in a Windows environment. It even says that at the top of the .NET website: "The .NET Framework is a development and execution environment that allows different programming languages & libraries to work together seamlessly to create Windows-based applications that are easier to build, manage, deploy, and integrate with other networked systems." (Emphasis is mine.)
Microsoft doesn't want alternatives to its computing paradigm, which is the default around the world. That part is natural. What I've been pointing out is that precisely that instinct is what's behind the Yahoo bid. Microsoft says it's about advertising. In part, perhaps, but it's mainly about gathering as much firepower as it can to prevent the emergence of entirely internet-based operating systems and applications that require no Microsoft products. I've long contended that such alternatives are on the way from both Google and Yahoo, and then Microsoft made its bold move to buy Yahoo.
Visar concluded:
Let's not forget the power of the status quo. How much training would it take to move to different platforms and software solutions? I would hate to live the day when I would have to re-train my parents to use a new operating system or Office Application suite, regardless of how similar they are to Microsoft's. I have seen many great solutions die due to user's attachment to older and much less efficient solutions.
There's some truth to this, but I think it's not insurmountable. The changes going on are deeper than just how to do the same old stuff a different way. The very reason people turn on computers is changing. The old standbys of creating a letter to be printed, mail-merging and printing it, and then saving the file in a heirarchical directory are done less and less. Most people these days are turning on their computers mostly to get online. Increasingly, they're doing online what they used to do from their hard drives.
It won't take too many more years of that before the mass realization that online is more important than hard drive takes effect. By then, alternatives like the gOS and Google Documents will be even better and with more users, creating the very network effect that has locked Windows on top.
Also, free software leading to cheap computers is a pretty powerful incentive for change. If Visar's parents would like to communicate with their son long distance for free using Skype, maybe the $199 Everex gPC would be more compelling than a more expensive Windows machine. The machine was so popular that even Wal-Mart's legendary inventory management system couldn't keep it from selling out last fall.
About the gPC, CNET News.com's Erica Ogg wrote on January 24:
It sounds simple, but most of what the average user wants to do with a computer these days can be done online: word processing, spreadsheets, e-mail, photo editing, and more, which means less storage is less of an issue. You want e-mail? Gmail and the included GTalk instant-messaging feature are free. And Google's Docs and Spreadsheets Web apps get all of your office productivity done online (though most of the three PCs have open-source versions of Microsoft Office). For watching videos, there's YouTube and Hulu.com. And rather than downloading a photo editing tool, anyone can upload their photos to Flickr and use Picnik's editing software right in the browser.
The success of devices like the gPC and Mirus Freespire--both are sold out at Wal-Mart and Sears.com, respectively--and even the more expensive and portable Eee PC, is a surprise to most.
"The success is, in part, driven by the fact that for people doing an increasing percentage of day-to-day tasks like e-mail in the context of software as a service, at that point it soon doesn't matter what operating system you have," said Redmonk's O'Grady. "If a majority of (computer) usage is browsing the Internet and doing things like that, (Linux) is perfectly credible, perfectly usable."
Some readers pointed out to me the fact that the gOS is just a customized version of Ubuntu Linux, which is free to anybody. About this, Glenn wrote, "I fail to see what this has to do with Google or Yahoo. Google could come out with a Linux distribution that may appeal to the masses but how would it make money? I can tolerate advertisements on a Web page but not on my desktop background, menu bar, etc."
Many others said they, too, would balk at using a Google or Yahoo operating system that forced them to see ads every time they turned on their computers. I feel the same way. So far, though, Google has been pretty good about keeping ads from interfering with its other free services, such as Google Earth. I would imagine that just building the Google search function into a free operating system would provide Google with enough additional revenue from its existing search advertising business to more than off-set the development costs and server costs to provide the OS. Plus, there could be add-on sales or premium versions as profit centers. After paying $200 or $300 for Windows Vista (depending on the version), most people would not mind at all paying Google or Yahoo $50 for a deluxe version of their internet-based OS.
I don't know exactly how the revenue model would work, but there are ways other than advertising to extract profit from an operating system.
The reason Microsoft is willing to do whatever it takes to win Yahoo is that it must. From a Tuesday night Reuters story:
Microsoft Corp will authorize a proxy battle for Yahoo Inc this week to convince the Web company's shareholders to agree on a takeover deal that the Yahoo board so far has rejected...
If Microsoft decides to launch a proxy fight, it would nominate a slate of directors to take control of Yahoo's board and support the company's proposal. The nominees would be voted on at Yahoo's annual shareholder meeting in June.
Microsoft would also risk alienating Yahoo's rank-and-file by taking a hostile tactic. Unlike manufacturing companies with fixed assets, a key Yahoo asset is its engineering talent, and a hostile approach by Microsoft could lead to an exodus of Yahoo talent to Google Inc or other Web rivals.
A reader who is a cross platform developer, pointed out that this is not the first time Microsoft has worried about losing its monopoly position via the internet. He wrote:
The browser wars were not about browsers, but were really about Java. When you installed Internet Explorer you installed the Microsoft version of the Java runtime and that version was meant to be a Java killer.
I have used a number of so called "cross platform" libraries, but none of them has really solved more problems than they have created. Java, on the other hand, was the best cross platform tool I have ever used. For the first time I could program considering only the problem to be solved and forget about the platform specific assumptions. Java works by using a virtual machine, or VM. The code for the VM is platform dependent, but the Java code that runs on it is exactly the same on a Mac, PC, Linux, Unix system, etc. Well, almost, that is: this is where Microsoft comes in.
The biggest barrier to the development of a new OS is that until the OS has significant market share the developer community will not write significant applications for it. The OS will not attain significant market share until there are significant applications for it; chicken and egg.
There was for a while a groundswell of Java based office productivity tools under development. What that meant to me as an OS developer was that if I write a Java VM for my platform, I would be able to offer Java based office suites (significant applications) until native applications that used my unique capabilities were developed. This was the real threat to Microsoft.
To combat the Java threat, Microsoft created its own version of the Java VM even though Sun had already produced one for the PC. The basic premise of Java is that the VM always looks the same to the Java code. The Microsoft VM was different from every other runtime and did not follow the Java specifications.
Microsoft added its proprietary ActiveX extensions to its VM and used their compiler tools to encourage Java code that heavily used the extensions, thereby rendering it completely dependent on Windows. As I said, when you installed IE, you got the Microsoft Java VM.
Microsoft may have lost some part of the browser wars in court, but by the time they lost, Java was dead as an application developers tool. The Java based office suites were all cancelled due to the uncertainty in the Java world. Microsoft was so successful in pursuing its real objective that it killed Java end user applications without it ever becoming an issue. Thus, you think this is the first time in history its OS and office businesses are vulnerable.
It's not.
To make this fight even more exciting, remember that Google CEO Eric Schmidt was once the Chief Technology Officer at Sun and became the CEO of Novell in 1997.
In both cases, he was stopped cold in his tracks by Microsoft's shenanigans to keep open solutions from happening. It killed Java's potential as described above, and it killed Novell's NetWare by making many of its features standard parts of the dominant Windows OS. From Wikipedia's Novell entry:
By 1999 Novell had lost its dominant market position, and was continually being out-marketed by Microsoft, which gained access to corporate data centres by bypassing technical staff and selling directly to corporate executives. Microsoft worked to make NetWare look second place with Windows 2000 features such as Group Policy.
Does anybody doubt Mr. Schmidt's desire to see Microsoft's monopolistic grip on computing broken?
Regarding Mr. Schmidt, Microsoft CEO Steve Ballmer said in an incident a couple of years ago, "I'm going to bury that guy. I have done it before, and I will do it again. I'm going to kill Google. . . . Google's not a real company. It's a house of cards." Note that I paraphrased. To see the decidedly more graphic original, click here.
So, this bid for Yahoo has precious little to do with ads, as I mentioned last Friday. It's not hard to see where the motivations come from.
Microsoft has attained its heights by copying other ideas, then out-marketing the originators of them or making the originators irrelevant by giving away comparable function as features in its OS, which comes standard on all PCs. They did that to Google's CEO twice before in his career. In both cases, he was not in a position to fight back the same way because his company made money by selling the product that Microsoft was giving away.
What he needed was a source of revenue completely separate from Microsoft's bread and butter, that he could use to bankroll the development of a free alternative to Microsoft's bread and butter.
Now, he's got it and can finally fight the giant with the giant's methods. Microsoft could give away a standards-killing version of the Java VM because it didn't need revenue from Java to survive. It could give away some capabilities of NetWare because it didn't need to sell networking to survive.
Guess what? Google can give away an operating system and productivity applications because...it doesn't need to sell them to survive. Moreover, the way it makes money is through advertising, and there are ways to incorporate ads into an operating system or productivity suite that might make the free versions profitable to Google in the future, while still leaving Microsoft unable to sell either Windows or Office.
Lest you think Mr. Schmidt has forgotten that Microsoft killed Java by giving away Internet Explorer, remember that Google loves Mozilla Firefox. True, it's so much better than IE that it's basically the only browser any intelligent company would endorse, but more than that it's not Microsoft, and for Mr. Schmidt that's an essential part of the big picture.
Meanwhile, back in Ballmer Land with the flying chairs and roared expletives, priority number one has become beating Google at any cost. Apparently, that's literally the case as the price for Yahoo is rising by the week. The acquisition will not only be expensive financially, it may be very costly in terms of talent lost at Yahoo and time lost as the cultures attempt to mesh.
No matter, Yahoo must be absorbed into the Microsoft empire and focused wholly on putting Windows dependencies into all of its offerings. Remember that you read it here first when Yahoo Mail is functional only via Internet Explorer. Try using Google Firefox, er, Mozilla Firefox and you'll get an error. Same with Flickr. And so on.
Yet, as good as that sounds for Microsoft's situation, we're still not at the reason it's in a hurry to get better positioned against Google's inevitable OS release. That reason was sent to me by another reader named Jeffrey. Look at this:
That's the gOS, the internet based OS I've been writing about for weeks now (but didn't know already existed) and predicting would be the way of the future. I had the time frame wrong, it seems. This operating system is available right now for free.
Look at the icons along the bottom. Every one of them is an internet application. You can use every one of them without ever touching a Microsoft product. Oh, and by the way, notice which browser is prominently featured on the left.
No wonder it's not safe to be in the same room as Mr. Ballmer these days. With Google Docs knocking at his door and gOS peeking in his windows (so to speak), he's bound to be irritable.
Disclosure:The Kelly Letter owns shares of MSFT and YHOO, and is looking for the right time to sell both and put the proceeds into GOOG for the long haul.
I've written extensively about the threat Google and Yahoo pose to Microsoft. My premise is not that online advertising is the big concern, but that it's a revenue model that will provide initial profits to bankroll the development of internet-based alternatives to Microsoft's core business, namely the Windows and Office franchises.
The angle has been met with more skepticism than I expected. Based on what I'd heard through my circle of friends and contacts, I thought nearly everybody was rooting for a company to finally challenge Microsoft's iron grip on computing, and believed that Google and Yahoo were working on it.
Then came Microsoft's bid for Yahoo a couple of weeks ago. The press reported mostly what Microsoft stated as the reason for its interest in Yahoo: to create a stronger rival to Google's online advertising business. Here at The Kelly Letter, we never bought that idea.
Folks, Microsoft is in imminent danger. It's not worried about missing out on a big business opportunity (online ads); it's worried about remaining a necessary path to working with a computer (the OS and the productivity software). For the first time in its history, Microsoft is facing competition that has a chance to unseat it from the PC monopoly chair that it's occupied for so long.
I received a raft of email from people more computer savvy than I suggesting that I stick to investing and leave the technology forecasting to others. "It's obvious from your summmaries that you have no idea how the core parts of an operating system function," wrote one man.
He's right about my not knowing the guts of operating systems, but do I really need to know how they work to see an alternative way forming? Was it necessary to understand steam locomotion to notice that cars were becoming more popular than trains? Was it necessary to know how cassette tapes were made to see that CDs and DVDs and eventually MP3s would win out in the end? I don't think so.
Similarly, I may not know the process behind coding Windows Vista, Office, Yahoo Mail, or Google Docs. What I do know is that there are no more software stores where you buy computer software in a box, take it home, and install it from disks. Everything I get comes from the internet now, and it's probably the same for you. That's an actionable trend. As goes everything else digital, so will go operating systems and productivity software, and the same thing that happened to Egghead Software's profits could happen to Microsoft's.
Finally, I discovered that I'm not the only one who thinks the Microsoft bid for Yahoo is about more than ads. Rob Cox and Jeff Segal wrote at Breakingviews on Monday:
What if the deal isn't just about online advertising? What if at stake in the battle is the very survival of Microsoft's core software business? Microsoft would never admit that so much is on the line. But there is a case to be made that acquiring Yahoo would go beyond rectifying Microsoft's online business to strengthening the moat protecting its franchise on desktops around the world.
Google sees a future where customers bypass Microsoft to use applications, like spreadsheets and word processors, which it offers for free on Google Docs. So far, Google Docs hasn't dented Microsoft's desktop dominance. But its growth is impressive. In November, unique users of Google Docs surged to 1.6m from 600,000 in June, according to Compete.com. And Google says 2,000 new companies start using its Google Apps subscription-based business software each day.
I think this view that the real reason for Microsoft's interest in Yahoo is the future of Windows and Office will gain popularity. As it does so, I expect people to conclude that Google has the upper hand because Microsoft will kill whatever progress Yahoo was making, leaving only Google as the alternative to Microsoft. More about that idea here.
If it comes down to who makes better online applications, Google or Microsoft, only a drunk would put his money on the latter.
Recent articles on the race to develop an internet-based operating system sparked a debate between Ben, who thinks it's inevitable, and Eric, who thinks there are major obstacles in the way.
This morning, I pass along the latest from Eric. It comes in response to Ben's points made last Thursday. You can follow the whole thread here.
Security Ben mentions banks having your social security number and financial information on file. Yes, that is what banks do. They not only have your social security number, but also your life savings in their hands. Luckily for us, banks are designed to be a safe house for such information. Their entire business operation is built upon protecting data, through layers of security. I'm not just talking about internet security, but also information management security. Banks are also FDIC insured for $100k. Will Google go to the same measures to provide the same type of security? Will they pay you $100k if they lose your data?
Data sensitivity extends past your personal information. Corporations and businesses have proprietary information that is worth millions, if not billions of dollars. I doubt GM executives are willing to store concept information pertaining to their next "big thing" on Google servers. The Department of Defense, one of Microsoft's biggest customers, will not store their classified information on Google servers.
Connectivity Broadband access in the world has grown exponentially. The United States can proudly say most of their hotels provide internet access. But that isn't necessarily the case in other countries. Even if broadband is available, are you willing to pay $15/hr do work on your laptop at the airport?
Free OS I state again: Nothing in this world is free. Wikipedia and online tech support boards are text based resources. Microsoft spends billions of dollars developing, testing, and maintaining their OS. The amount of dollars required to update patches, fix bugs, update drivers (just to name a few) will not be fulfilled by donations. Linux has been an open-source for years. Have you tried downloading Linux source-code from the internet? There is a reason why Linux companies like Red Hat exist.
Though Ben's arguments are logical, they represent the world of your teenage internet user. The reality is, what he disparages as "the average 40-55-year-old adult" is the group in position to make the decisions on where to spend IT funds. If you can't convince these hard headed people who just don't understand the miracles of technology, then there will not be an internet-based OS market, which means disappointing stock prices, and stock prices are what we care about here at The Kelly Letter.
If you have any insight into the development of an internet-based operating system alternative to Windows and the Mac, please pass it along to me.
Recent articles about an internet-based operating system have generated heat.
Eric mentioned on Tuesday some challenges to the concept, which I addressed. His three points were that security concerns would keep people from trusting an internet-based OS, spotty broadband connectivity would make it hard to use in some places, and nothing in life is free.
This morning, I pass along to you a rebuttal to Eric's points, submitted by Ben:
Eric represents the average 40-55-year-old adult who still doesn't realize how powerful technology has become. My dad is that age, and he just doesn't understand the capabilities of the Internet.
To Eric's points.
Security We already send our information to other companies. Jason bills his [Kelly Letter] subscribers through PayPal. That company has Jason's credit card numbers as long as everyone remains a subscriber (Eric included) and Jason obviously trust PayPal. Online banks have all of their customers' social security numbers. These are companies too, and if Google or Yahoo would violate this security, they would be bankrupt in days. They don't want to go bankrupt, so I would have no problem trusting Google with my information. Why would Google look at its users' documents [stored on its servers] when they are meaningless to them and would cause them to go into bankruptcy?
Connectivity Not more than a decade ago broadband was unheard of, and if you were lucky enough to have this "fast internet" you were blessed. Now, computers aren't even made with dial-up ports, and new computers such as the MacBook Air operate only on wireless technology. Let me repeat that: the newest computer on the market is able to connect to the internet only through wireless technology. I have no doubt that in less than a decade the entire world will be wireless, it just depends on which company's satellite in space you want to pay for to have the internet sent to your machine.
Free Eric states that "nothing is free in this world." That is simply not true anymore. Of course, before the internet, things were materials. They took up physical space, and it cost something to manufacture them. But now, with the internet and with people who have way too much time on their hands, getting great things for free is possible.
Consider this real life example that happened to me. My computer was acting up a couple of months ago. I could have taken it to the store, waited a week, heard their excuse about why it wasn't fixed yet, driven to pick it up and paid them a ridiculous amount of money. Instead, I simply went to a computer message board, posted my problem, and 6 minutes later I received an answer from a computer engineer in Iowa. For free. In 6 minutes. A half hour later my problem was solved.
This is the power open-source software has. You or I might not have free time to help people out for free, but there are people all over the world who enjoy their field enough to help others out on message boards.
I can see Google creating an OS and then letting it be edited just like Wikipedia and running off of donations. Or just like Facebook is letting regular people develop applications. Wikipedia is quickly becoming the single best place to get information anywhere in the world. And guess what? It is free. Go to their website and look at how many people donate to the site. And if Google created an OS, people would donate, too.
Eric complains about possible ads on his background. How many ads do you see on Wikipedia?
If you still think that nothing is free, you are living in the past. Get with the times, or you will miss out on incredible opportunities in the technology market.
Then again, without people like Eric, Google would be around $1,800 instead of this dirt cheap $502 nonsense.
Thanks, Eric.
Note that The Kelly Letter is currently looking to buy shares of Google on the cheap in anticipation of its eventually offering a free, downloadable, internet-based operating system that usurps Windows.
So, while dirt cheap yesterday's GOOG close of $502 may be, we would welcome an even dirtier cheaper price of, say, $400. Do what you can to help. Sell your GOOG shares in a panic during one of these downturns.
My article yesterday prompted excellent feedback. I'm lucky to count dozens of technology insiders among my readers.
What many pointed out is that an internet-based operating system would face major challenges, three of which were summed up well by a subscriber named Eric:
Security Moving critical functions online into the hands of a service provider (i.e. Yahoo or Google) would pose significant risks and the possibility of compromising data. People like to keep personal information private, and businesses rely on proprietary or sensitive information to give them an edge for success. Are people/businesses willing to put all this in the hands of Yahoo or Google? To me it doesn't matter which company is providing the service, I would be very reluctant to entrust a third party with my information. By the same token, the services providers would be reluctant to take on the responsibility of data losses and spillages.
Connectivity While broadband is becoming prevalent across the world, it's not everywhere yet. I travel frequently for my job and have found the hotels, conventions, and local hotspots equipped with reliable internet connections. However, there have been times when I have been stranded without an internet connection due to circumstances beyond anyone's control. Sometimes, things just don't work (especially in less developed foreign countries). I can imagine being stuck in a situation where I cannot get to my files/data. The loss of productivity would be painful enough to pay whatever licensing fee for a standard desktop OS.
Free Nothing is free in this world. I find it hard to believe the OS service providers would be happy to build out million-dollar server farms and not charge a dime for using them. My assumption is that fees and charges will be factored in later as the concept/technology develops (perhaps after they claim their market share). Or advertisements will be plastered all over the desktop workspace. Both options I find very annoying.
While these are good points, I think what we'll find is not an entirely online operating system, but downloadable parts of an operating system that rely on the internet to create much of the functionality we get from our hard drives now.
For instance, say we download a packet of files that is the core of Google OS. It has drivers to print documents, run peripheral devices, and put a graphical user interface on the screen. However, familiar tasks could be done with internet support instead of entirely from the hard drive.
If I double click a document icon, for instance, up pops a window with my document in it exactly as if I opened a Word document in Windows. Instead of being a Word window, however, it's a Google Docs window. It doesn't matter to me. I get my work done, save, and print if I need a hard copy.
If I want to browse my files, I open a file explorer equivalent to the familiar heirarchical folder representation. Depending on how I set up my options, when I click to open a folder I'm either viewing locally stored files or peeking into the folder where it's stored online. Eric is right that we all have certain files that we don't want to throw online no matter how safe we're assured they'll be. Those we place in folders that we specify to be saved on our hard drive only.
None of this is a stretch so far. Google Docs works right now, and we already specify private and shared folders for services such as Limewire. Other Limewire users can get to the files in my shared folder, but not the ones that are not shared. Similarly, I could store some files online in my own private directory but where I might be skeptical of their really being safe, and others in the directory on my hard drive.
Some say Linux is already doing this. They accuse me of calling for a revolution where there's already been one. Well, the internet itself has been around since Sputnik, but according to Wikipedia, "the rapid growth of the internet was due primarily to the availability of commercial routers from companies such as Cisco Systems, Proteon and Juniper, the availability of commercial Ethernet equipment for local area networking and the widespread implementation of TCP/IP on the UNIX operating system." All of that didn't show up in meaningful quantities until the 1990s for your average end user.
Similarly, Linux may have been around for a while, but we have yet to see a tipping point where ordinary folks are using a freely downloaded operating system on their computers, and not caring what hardware they buy because the free OS runs on anything with a screen.
True, Linux is a free operating system alternative that anybody can download today, but just try setting it up on your personal computer. I have. It's complicated. First of all, there's no one place to get it. There's not even a standard interface. You have to navigate your way through KDE, GNOME, and Xfce among others. IT professionals may consider Linux to be a viable option, but for the masses it's strictly a concept for the time being.
It's done a lot of way paving, though, if mostly in the realm of showing ordinary folks a different way of computing is possible. Here in Japan, many people are not even aware of the existence of an operating system, per se. I asked a woman if she liked Windows and she wondered what I meant. When I explained to her, she said she always thought that was just what computers were.
The company that finally shows people there are simple alternatives to Windows available to everybody for the first time because of the agnosticism of the internet, stands to make a mint. That's what I was driving at yesterday. Apple has had a hard time of it until now because of compatibility issues, but those are disappearing, again courtesy of the internet.
As an aside, I think Apple will continue doing well precisely because more people can finally choose Mac over Windows. Both can get online, after all, and online is all that matters anymore.
I wrote in yesterday's article, "Google Docs is already pretty far along toward replacing Office..." and people wrote to tell me that's not true yet.
I'll clarify. I didn't mean GDocs has taken significant market share from Microsoft Office, I meant its capabilities are enough for most people. The majority of computer users never touches some 80% of the features in bloated office software. They just want to type a letter, paper, or other simple document and get page numbers in the right place. That describes most casual computer users and, for their purposes, GDocs is sufficient.
To experiment with that idea, I moved my business operation spanning two continents entirely to GDocs and Open Office last autumn, and it's been fine. It's been more than fine, in fact, it's been great. No more emailing attachments back and forth. Revisions are automatically tracked. No need for backups.
My goal was to run my business in such a way that if my laptop were stolen at an airport, I could rush to the nearest internet-connected computer running any operating system and keep working. You know what? I can do that, thanks to GDocs, our online database server, internet mail, PayPal, online banking, and so on. Try that with hard-drive based Windows and Office.
Eric mentioned that not everywhere is connected. Conceded, but what operating system would not include some kind of basic text editor for typing data in raw form until getting to a connected computer that can put the data where it belongs?
Almost anywhere in the world, I have access to every one of my business documents in editable, trackable, printable form at docs.jasonkelly.com. For free. Right now. No kidding.
Now, all of that said, there are some tasks that GDocs is not very good at handling yet, but it's improving all the time. Moreover, the reasons we create documents is changing as much as the way we create them. I would submit that a significant percentage of the capabilities of software like Word is irrelevant in a world that is creating most of its content for online usage. Take this article, for instance. Did I care one second about pagination, margins, font size, columns, or any of that hard copy stuff? Nope, I typed it online and it stays online.
As we progress, more and more of what Microsoft has developed over the years doesn't apply. It realizes this. That's why it's in a panic to buy its way to a longer future so it can figure out what to do when alternatives to its products are:
> designed better > made by companies that are not out to stifle innovation > and available for free
That last point is debatable, as Eric mentioned. Maybe internet-based operating systems will come with a fee at some point in the future. Maybe some will run ads. I would not like the latter. If the price was right, I would not object to the former.
To doubters, I offer one word: Firefox. It's free and it runs no ads. It just runs circles around Internet Explorer. What if Mozilla, creator of Firefox, pulled the same trick with an operating system instead of a browser? What if they did it with Google's help?
I wrote an article for Kelly Letter subscribers last week explaining how both Google and Yahoo are racing to deliver online alternatives to Microsoft Windows and Microsoft Office.
Google Docs is already pretty far along toward replacing Office, but the much bigger fish for the future will be a freely downloadable internet based operating system that can replace Windows.
That article could not have been timelier.
Indeed, Microsoft was so concerned about the internet threat that it made a bid to buy Yahoo for $42 billion last Friday. Prior to that, the largest acquisition Microsoft ever made was online ad company aQuantive for $6 billion last year. The huge offer for Yahoo shows how serious Microsoft feels about the internet's role in its future.
The cash-and-stock offer was worth $31 per share of YHOO as of Thursday's close, but only $28.95 per share as of Friday's close because shares of MSFT fell on news of the bid.
This changes everything.
My thinking on Yahoo for the past two years has been that it would command as much of the growing online advertising pie as Google. The online ad market in 2007 was about $40 billion. Because more people are getting more of their information online, online ads are on trend to hit $80 billion by 2010.
Yahoo has made great strides forward since 2004 when Google hit pay dirt with its fantastic ad system. Yahoo overhauled its own advertising platform with a new one called Panama that's doing well. It increased overall traffic and is the most visited online name. It made smart acquisitions including Flickr, the web's most popular photo site. It also snazzed up all of its properties, most notably Yahoo Mail and Yahoo Finance.
What it did not do was take search market share from Google. To this point, that's about all Yahoo has left to focus on and it's focusing on it very hard.
What I posited last week was that both Google and Yahoo had their sights set on delivering the world's first internet based operating system alternative to Windows and other hard-drive based operating systems. The first company to bring that to the world stands to unseat Microsoft from its dominant position at the center of computing, control most of the online ad market and, indeed, become to the internet what Microsoft has been to the hard-drive based personal computer.
While I felt it was too soon to say whether Google or Yahoo was farther ahead in the effort, I was willing to continue betting on Yahoo because of its cheap valuation. Part of the reason is now abundantly clear. Even if Yahoo couldn't make it on its own, it was a fabulous takeover candidate.
The Kelly Letter owns both Microsoft and Yahoo, and did well overall on the news. MSFT dropped 6.6% but YHOO gained 48%.
Microsoft has not purchased Yahoo yet. We need to be clear on that. It made a bid. Yahoo did not offer itself for sale. The only thing Yahoo had to say Friday was that its board will carefully consider the offer.
Microsoft President Steve Ballmer said on a conference call Friday, "This is a decision we have -- and I have -- thought long and hard about. We are confident it's the right path for Microsoft and Yahoo."
From which we should assume Microsoft will not give up easily.
Yahoo, however, may not give up its independence easily. Forrester Research analyst Charlene Li even suggested Yahoo would outsource its search engine operation to Google if that kept it out of Microsoft's jaws. About that idea, Paul Kedrosky wrote, "Ironic, huh? Yahoo needs Google to save it from Microsoft to save it from Google."
Other suitors will undoubtedly show up, and already lists of possibilities are making their way around the internet. That would be good for Kelly Letter subscribers as YHOO owners, because more demand will drive up the price.
Where does that leave us?
For now, right where we've been all along with shares of MSFT for its reinvigorated profits from new software versions. The company is in no danger of being unseated in the next year or so.
As for Yahoo, I'm interested in it only as an independent company. We'll gladly hold shares while they appreciate in the hot light of merger demand, but that'll be the end.
Beyond that, for the first time, I'm willing to say the future belongs to Google. I believe Microsoft will destroy the chance Yahoo had because the best thing Yahoo had going for it was the potential to integrate all it had built over the years into an internet-based desktop that anybody could download for free.
Microsoft could kill that project. Doing so would be stupid, though, because it would leave only Google working on it and leave Microsoft as vulnerable as it is right now. There would be little point in acquiring Yahoo.
More likely, Microsoft will make the Yahoo desktop into the online version of Windows Vista. That will do nothing to give people what they've wanted all along, which is an alternative to Microsoft's iron grip on computing. The Micrahoo Vista Internet Desktop will be a colossal thud, encumbered by Microsoft's infamous complexity and mired in all the monopolistic hooks and dependencies called "features" in everything from Redmond.
It will be the entire marketing plan around the far superior, simple, elegant, and independent desktop on the way from Google. The only tagline Google's desktop will need is, "The one that ain't from Microsoft."
This is great news for Google. Its only rival is in danger of disappearing into the un-innovative maw of Microsoft, the same company that made Hotmail an also-ran in online mail, and cemented MSN's position as such a distant alternative to Google and Yahoo that nobody even mentions it except to make fun of Microsoft.
That makes The Kelly Letter's new strategy straightforward. We'll hold YHOO while the bidding takes place. If it's acquired by Microsoft, we'll combine the shares we get in return with the ones we already own, and start looking for an exit point.
Finally -- drum roll, please -- for the first time ever we'll be looking to buy shares of Google. I've been watching GOOG for years, and it's always looked too expensive. With its recent profit pace slowing, the share price has fallen 30% since November 6, making it more tantalizing than it's been in a while.
What I'm hoping for is a widespread misunderstanding that Microsoft acquiring Yahoo is going to create the tag team that will take Google down for good. That, combined with Google's slowing profit growth and remaining development time of Google's internet-based operating system, may depress the price of GOOG even further.
This could give us a perfect chance to sell Micrahoo at a profit, and bet on Google.
Breaking news hints that we may get precisely that scenario. Google itself is creating the impression, as reported by the Associated Press:
Microsoft has been trying to depict a Yahoo takeover as a boon for both advertisers and consumers because the two companies together would be able to compete against Google more effectively.
But Google is painting a starkly different picture, asserting that Microsoft will be able to stifle innovation and leverage its dominating Windows operating system to set up personal computers so consumers are automatically steered to online services, such as e-mail and instant messaging, controlled by the world's largest software maker.
In a move that illustrates just how badly Google wants to torpedo the deal, Google Chief Executive Officer Eric Schmidt called Yahoo CEO Jerry Yang Friday to offer his help in repelling Microsoft, according to a report Sunday on The Wall Street Journal's Web site, which cited anonymous people familiar with the matter.
See what I mean? Everybody knows Microsoft's tricks. Everybody knows it wants to make the same mess of the internet that it made of the personal computer, with all money channeling back to it as it puts up barriers to innovation in all directions. Everybody's sick of Microsoft.
Microsoft should well be terrified of the day a free online alternative to Windows hits the internet. Starting on that day, the countdown to Microsoft's irrelevance could be measured in quarters, not years.
You know how long it would take me to switch? Only as long as the download. When the installation prompt asked me if I wanted to save a backup copy of my former operating environment, I'd click "hell no" as fast as my fingers could move.
And -- poof! -- just like that Microsoft would be gone.
Google thinks it's found the next way to squeeze ad dollars from the internet. It's going to run translucent ad panes at the bottom of videos at YouTube. It hopes to combine its AdSense system, which contains the web's biggest database of online advertisers, with YouTube, which attracts the web's biggest video viewing audience. If this works, it could be the next leg up for Google over rivals Microsoft and Yahoo.
There are problems, though:
Most video content at this stage is bad, made mostly by bored teenagers
It's a lot harder for an advertiser to make a good video commercial than it is for them to type a text ad
Video content is more subjective than search keywords, making it harder to keep ads relevant
Anybody who spends much time on YouTube is not part of a desirable demographic, by virtue of their having nothing better to do than watch mindless amateur videos
To be fair, not all the clips at YouTube are lowbrow, nor all the viewers. From what I've seen, though, it's hardly an Overachievers Anonymous recruiting ground.
There's potential here, but it doesn't look nearly as promising as Google's original AdSense and AdWords. To me, this latest move is evidence that Google is grasping at straws for its next revenue stream because its existing text ad business is about tapped out, it has nothing in the way of non-ad revenue to grow, and it needs to do something with YouTube besides defend itself against copyright infringement lawsuits.
Morgan Stanley Internet Analyst Mary Meeker wrote last week that the new ads could create $4.8 billion of gross revenue and $720 million of net revenue in Google's annual results. That looked startlingly high to a lot of folks, and Henry Blodget decided to look into it:
Well, we were baffled at how Mary could be so amazingly bullish, so, on a tip from a reader, we checked her numbers. And it seems Mary may soon be revising her estimates. Why? Because, in advertising lingo, "CPM" means "Cost Per Thousand" not "Cost Per One." When Mary updates her model to divide by 1,000, her numbers will look a bit different.
What happens to Mary's estimates when you do the math right? Well, that $4.8 billion of gross revenue becomes $4.8 million, and the $720 million of net revenue becomes $720 thousand. So if, as Mary suggests, Google can float ads on top of 20 million streams a month, secure a $20 CPM, and keep 15% of the gross revenue, the overall impact will actually be, as we suggested yesterday, immaterial.
You may have noticed that there are no Google text ads on this page anymore. I pulled all of them because they were increasingly irrelevant to my content, distracting to my readers, and suffering from a declining revenue stream to this site despite the site's growing traffic.
That's fantastic real-world research, and I continue to think Google is vulnerable to a slowdown in its ad revenue, which is to say, its only revenue.
My article last Friday, Google vs. Microsoft, was picked up by Seeking Alpha and started a discussion between two members of that site who are online advertising professionals. I'll respond to their comments here.
Jeff Molander of Molander & Associates wrote that he thinks Google is attempting to clean up its AdSense network, most notably with a "Pay-per-action scheme and kicking out the made-for- AdSense crowd."
This would be a welcome development for all web searchers. Pay-per-click is easily abused because Google gets paid for a click whether it benefits the advertiser or not. Pay-per-click was seen as a major advantage over pay-per-impression because it showed the advertiser that they didn't pay unless they got results.
However, advertisers like Ron Davis (whom I quoted last Tuesday) and me noticed long ago that even clicks from Google ads don't necessarily work, and get expensive quickly. A click, it turns out, isn't much of a result. There are no figures available for how many clicks are from genuinely interested parties and how many are from people clicking ads on their own site to get money, competitors clicking ads to use up a rival's budget, and other forms of click fraud.
So, a pay-per-result or pay-per-action model would go a long way toward making advertisers happy again. If you're selling a $50 item, for instance, and your profit margin is $25, you have a lot of money available for bidding on the result of actually selling it. As it stands now, you have to watch carefully the percentage of clickers that buy it, figure the highest amount you can pay to afford all the deadweight clickers that come with every buying clicker, and then budget accordingly. The result is an ad plan that gets so slimmed down from the crummy performance of Google's text ads these days that it's just not worth it for many people.
I hope Google's clean-up efforts continue, and that the rest of the industry follows along. In the meantime, though, the deterioration of Google's model spells trouble for the only way the company makes money, and is what may give us a cheaper stock price.
Derrick Shields of Adscape wrote that he doesn't "think it was GOOG's intention to 'trick' users into clicking on contextual, text-based advertisements."
Maybe not, but it's become clear over the years that a lot of the early success of the text ad came from the way it blends into a page and looks like part of the page itself. People clicked away at anything on the page, not being careful to see that it was an "Ad by Google" that they were clicking. Now, that low hanging fruit is gone. People know where the text ads are placed in search results, know where to find the "real" results versus the paid, know how to spot a text ad block from a mile away on a third-party website, and so on.
Derrick wrote, "What you are saying is akin to saying that television commercials are no good because consumers are aware that the brands/advertisers paid to have their commercial shown."
This is an interesting example. It doesn't matter whether we all know that a commercial is a paid spot or not, what matters is whether we want to watch it. Evidently, the answer is a resounding "no." Whenever possible, people strip commercials from their favorite programs. All of us have seen a commercial that we liked at one time or another, but we still resent the interruption to our activity that advertising imposes.
It doesn't take a professional study to realize this. Let's say every TV program was preceded by a screen that asked, "Would you like ads interspersed throughout the programming or would you like the program to be ad-free?" Do you think the larger percentage of people would select the no-ad version or the ad version? The no-ad, of course, even though there will probably be some relevant, interesting ads in the mix that they'll miss.
It's the same online. If every website was preceded by those same two choices, almost everybody would elect to see the no-ad page, even if the stripped ads were text-based and relevant.
By the way, this is exactly why you're seeing more in-program advertising. Rather than running another 30-second Coke spot, Coca-Cola will pay to have the character in a sit-com drink a can of Coke and maybe even say, "I love this stuff!"
People don't resent advertising, per se, they just hate when it gets in the way of what they're doing. Ads hog page space. They creep into all the little areas that our eyes want to be clean. They create a sense of stress in the viewer because an abundance of links on a page makes it harder to focus on what to do next, what to read, where to go.
Google is an advertising business and has offered other ways to incorporate ads into smaller and smaller places on a page as the click rates for the bigger ad blocks dropped. Site owners can now put link bars into thin areas and they show just the category of ads that will appear.
There's nothing wrong with Google trying to get more people to click and perhaps even hoping that those clicks turn into business for advertisers. The problem is that they don't. Word is getting out. Something new is needed and soon, or Google's only source of revenue is in trouble.
Nobody in this discussion is naive. We know that advertising won't disappear, shouldn't disappear, but in the same way Google changed the face of online advertising with its text model, something is going to displace the text model in the near future. It's not clear yet whether Google will be the company that develops the next method of online advertising. So far, it hasn't shown much creativity. Other firms, including Microsoft, appear to be ahead.
Derrick wrote, "I think it's wrong to assume that the text-ads are irrelevant or not useful to the user. Let's say you did a search for 'cheap online brokerages.' Of course the top 10 organic results would be (hopefully) relevant but I think it would be fair to assume that the paid advertisements would be very relevant as well."
It would not be fair to assume that at all, and this is precisely my point. I searched Google for "cheap online brokerages" and found the organic results to be useful: a SmartMoney article on the best brokers, a CNN broker guide, and links to some brokers themselves.
The ads, however, disappointed. The horizontal ad on top was for Firstrade, relevant, clear, and fine. The vertical ads to the right of the results, on the other hand, were representative of the problem. The top one was just a collection of links assembled by Active Audience, a domain parking outfit. The next one was another collection of links by a similar outfit. Clicking either was a waste of the user's time because the result was not a broker at all, but a list of links inferior to the list that was already served up by the search engine.
That's why people stick with the organic results.
Derrick points out in a later comment that Google clearly differentiates its ads from its organic results. I agree. Everybody knows where the ads are, almost everybody avoids them, and there's good reason for them to do so.
The point of my article was that GOOG the stock looks vulnerable to revenue trouble from the declining performance of Google the company's ads. I still think that's true.
I wrote Tuesday about trouble with Google's AdWords platform. I noted that it's not performing as well as it used to, and that that will spell short-term trouble for the company and stock because 99% of Google's revenue comes from its ads.
On Wednesday, Digg switched from partnering with Google to provide ads on its reader-powered news site, to partnering with Microsoft. Digg will still display small text ads, just like the ones previously delivered by Google, but now they'll come from Microsoft and are expected to be better.
How could this be? Google is supposed to be the cutting edge of all things Internet, yet it's grown relatively stodgy in the ad business, which is its only revenue-generating endeavor. Everything else it does is just to gather people around pages that show content and...ads. If it blows it in the ad game, it's in real trouble because that its only game.
Meanwhile, old crusty Microsoft is leading the charge in the ad category. Jay Adelson, Digg's CEO, said his company couldn't "think of a better partner to get to where we need to go. They're a young ad service, they're innovative, they're willing to work with us on the cutting edge."
Last summer, Microsoft signed up the social networking site Facebook. Now it has Digg. It's in the process of acquiring aQuantive to keep its adCenter division at, well, the center of advertising.
Rather than Google's plain-Jane pasted-on-the-page ad system, Microsoft is developing a more interactive approach. Users have been screwed by too many worthless text ads that have, in fact, little to do with what they're doing online. The context sensitive approach was nice five years ago, but has been worked to death to the point where fewer and fewer people bother looking at anything but organic search results (the ones that the web turns up by actually searching, not the ones that are placed as ads). Everybody's onto the text ad trick by now.
Steve Berkowitz, a senior vice president in Microsoft's online services group, says Microsoft is the innovator, not the copy-cat, in online advertising. "We actually now are in the forefront of what we believe is going to be the next generation of advertising."
True, Microsoft has a long way to go to catch up with Google, but it certainly doesn't lack the money to get there.
I've written for some time now that my interest in Google has to do with its endeavors to make Microsoft alternatives. I want to use Google Docs instead of Microsoft Office, for instance, and I'd like to see an entirely free operating system made available and amazing, just as Mozilla has made the entirely free Firefox the best thing in browsing. Try using Internet Explorer after Firefox and you can scarcely believe anybody's stupid enough to keep it.
Is Microsoft taking Google's encroachment onto its core turf in stride? No. The Redmond giant is well aware that its main business is threatened by web-based applications, online advertising, and other ventures.
Last night, Microsoft CEO Steve Ballmer told analysts that web services and consumer devices are vital parts of the company's future. He said, "Great things don't happen overnight. Most successes require long-term investment and innovation...and that's our perspective."
He said he sees more opportunities for growth in the next 10 years than in the past 30 years. Rather than hiding from new, disruptive technologies, Microsoft will embrace them. He referred specifically to the threat of web-based software versus Microsoft's traditional local hard-drive-based software.
"Every piece of software -- the basic core value in the way software gets created -- will change in the next three, five or 10 years," he said, and predicted that all software will soon use the desktop, Internet, and server to get its job done. He said that software will never switch to an Internet-only model.
What's going on here?
Google is an online advertising company that has plans to become a software company. Microsoft is a software company that has plans to become an online advertising company. They're both much better than the other in their current area of strength at the moment, but they're both looking a little uninteresting in that area as the other catches up in exciting ways. They both have a lot of money to get where they want to be.
Microsoft shares were stuck between $22 and $30 from mid-2002 to mid-2006. From early June of last year to now, the shares are up some 36%, but that's just the difference from $22 to $30, so the situation hasn't changed all that much. Pay no attention to what excited onlookers say about the percentage gain.
Google shares are the toast of the town, having gone up 400% from $100 to $500 in the past five years. However, there've been bumps along the way. From January 2006 to mid-March 2006, GOOG dropped 28%. Could we be on the verge of another such sale?
I think so. It reported earlier this month that it hired 1,500 new people. It now has 14,000 people on its payroll to support all of its new endeavors, not one of which makes money beyond providing pages for ads. It's little surprise, then, that Google's operating margin has fallen from 35% two years ago to less than 29% now, and it's still falling.
I'd steer clear of GOOG shares for a while. Keep using all of its amazing services, keep loving the pressure it's putting on Microsoft to innovate, keep hoping that it announces one day an entirely free operating system, but let the sale around its shares continue.
This Weekend To Subscribers: How our watch list is getting closer to our target buy prices in this falling market, the profit potential of Japan, whether this is the right time to start a permanent portfolio at sale prices, and a look at the stock we purchased on Tuesday for a price much lower than what Morningstar suggested for this 5-Star stock.
Coming Soon On This Free Site: Good investment resources versus ones that just generate noise, Panera Bread versus Starbucks, Blockbuster versus Netflix, what's wrong with U.S. health care, and more.
Disclosure:The Kelly Letter portfolio includes Microsoft, currently up 33% for us.
On July 16, I complained about AdWords, Google's advertising platform, and cited decreasing return on internet advertising as a short-term weakness for Google. I pointed out that eBay didn't suffer during the week that it pulled its ads from Google, and related my own experiences with Google AdWords. I wrote, "I'll keep watching Google for a better entry price."
Well, we got it. Since that article, GOOG has fallen more than 7% as of yesterday's close at $512.51. I continue to think that the Google competitor we own in The Kelly Letter has more potential for appreciation because it's:
> Beaten down
> Well-positioned for changing advertising trends
> Benefiting from new management
> Not expected to do well, thus primed to pleasantly surprise
Since my article, others wrote in with their own AdWords experiences, and not one of them was positive. Most people contacting me asked that I not reveal the details of their stories for fear of having competitors take their keywords, start rival sites, and such. Unfortunately, without the details, most of the stories lost their impact.
However, Ron Davis agreed to let me reprint his story:
I specialize in training seminars for companies that want to implement business intelligence solutions using Microsoft technologies such as Sharepoint and BizTalk. That is what I was advertising on Google AdWords. Most of my traditional business comes through brokers who scout companies for needs like these. If I eliminate the brokers, [I keep more profit].
I used all of the key words that match business intelligence searches and had zero results over a 90-day trial period. I know companies do these types of searches yet I had no success and was lost as to the why until I read your stats on the organic searches.
I'm afraid the text ad gig is at a major inflection point.
Google's text ad business was brilliantly conceived and implemented. The reason its text ads destroyed banner ads is that they were unobtrusive, new, and looked like informational links. When you searched five years ago, the ads often provided the best information on the results page because they hadn't been hijacked by the spam gang yet.
Now, all that's changed. The proliferation of Google ads across the Internet, including on my own sites, has taught people that they are ads, not additional useful information. Just as banners lost their appeal, so have text ads. The click rates are dropping, as the studies I cited a few weeks ago show, and as my own experiences and the experiences shared by my readers reflect.
So, advertisers get fewer results. Oddly, they end up paying more for them because the cost per click -- when the clicks come -- is now too high.
Ads are no longer dominated by genuine sellers of services that might be of interest to people searching on certain keywords. I was an early adopter of Google's keyword text advertising, and it worked for a while. Using PayPal and Google ads, I sold a book I'd written on how to pay for long-term health care.
In less than a year, that business went from very profitable to barely breaking even to losing money solely on the increasing price I needed to pay per click. I paid more money to achieve fewer sales, and both trends continued to the point of making the campaign damaging to my bottom line rather than beneficial. My ads were copied and outbid by others, and I suffered from false clicks by competitors attempting to drive up my costs so much that it was no longer profitable for me to advertise.
It worked. I no longer advertise on Google, or anywhere else for that matter. Prices are so high on Google and the results are so low, that only major companies are using the service much anymore. The small businesses that made the text ads so appealing in their early incarnation, are gone. The usual gang that dominates advertising, and the spam gang that dominates online activity, have taken over.
When was the last time you clicked a text ad to your satisfaction? I can't even remember, because I stopped clicking them ages ago. I can tell from the decreasing revenues from Google's ads on my sites that others are clicking less, too.
Look to the left of this paragraph. See that ad block? Go ahead and try clicking some of the ads in it, and see if you go anywhere that has even the slightest chance of getting some business out of you. Probably not, yet that ad block is supposed to serve relevant ads that help you, the potential buyer, and the sellers who are paying for your clicks. They used to do just that. These days, they don't.
Lower income for me means lower income for Google, assuming that the accounting is done properly. I'm just one small example in Google's vast client roster, but not meaningless. If people are clicking less on the context-sensitive ads on my sites, perhaps they're clicking less elsewhere, too.
Indeed, that's what studies show and that's what readers report.
Coming Soon: More free online stock screeners recommended by readers, swing trading versus buying and holding, and the accusation that my permanent portfolio strategies are "beyond ludicrous."
Last month, eBay pulled its ads from Google for one week when Google threw a Google Checkout party at the same time eBay held its eBay Live conference. It seemed that Google was trying to siphon off some of the attention being focused on PayPal, eBay's online payment service. eBay later said that during the week it ran no ads on Google, it suffered a 0% loss in traffic on its site.
That was an eye opener not only to eBay, but also to the rest of the online ad industry. A full 99% of Google's revenue is from advertising. Everything else Google -- Documents, Gears, Gmail, Earth, YouTube, and so on -- is for show. Remember this the next time you read a gushing report saying that Google's YouTube now commands 60% of the online video market in the U.S. Amazing, but so what? People with nothing to do go there to watch videos...for free. The trick is that those videos are surrounded by ads. Right now, ads are the whole profit story at Google. Any vulnerability there is a major chink in Google's armor.
I pointed out to Kelly Letter subscribers a few weeks ago that I stopped advertising on Google because its keywords became too expensive and the results unimpressive.
Come to find out, it wasn't just me. Search users are six times more likely to click the first few organic results than any of the paid results. Organic results are the ones found naturally by the search engine. An eye-tracking study found that half of all users start their search by scanning the top organic results. Another study found that only 30% of search engine users click on paid listings. Yet, between October 2004 and December 2005, average keyword prices rose from $25 to $55. Yet another study found that 57% of U.S. advertisers considered their desired keywords to be "too expensive."
So far, Google has held onto its lead in search and still commands the lion's share of online advertising. But advertisers are not stupid. If getting better placement on a search engine produces better results for less money, that's where the trend will go. Then, Google's revenue source will be in trouble as advertisers discover -- as I already have -- that other search engines turn up better results than Google's.
For instance, if you haven't tried InterActiveCorp's Ask.com recently, you should. I've written about it before and it's only gotten better in the last few months. It's faster than Google, more accurate, less cluttered, and is chock full of features that will make you say "Wow!" as you click along and use it. You can even choose your own skin for the background of the engine's home page, and it expands or contracts to fit beautifully inside your browser's current size. Google looks rusty by comparison.
Bottom line: I'm happy to own in The Kelly Letter a different online search and media company over Google for the medium term. Shares in the company we own haven't moved much since we bought, and that's a good opportunity for new subscribers. Usually, newcomers complain that all our existing positions are up too much, but that's not the case with this one.
I'll keep watching Google for a better entry price because I think the company's real story is not its advertising acumen, but its unique chance to unseat Microsoft. That potential is building and I think one day we'll look back and see the advertising phase as just the first revenue stream that enabled Google to gather resources to build a viable alternative to Microsoft Office, and ultimately Windows. That's the story I want to own, but not yet, because I think Google will get cheaper from turmoil in the ad business.
SiCKO You've surely heard or read about Michael Moore's new film, SiCKO, by now. It shows that we need to take the profit out of U.S. health care. I haven't seen it yet, but I will as soon as it comes to Japan.
Longtime readers know that my mother was severely injured in a horseback riding accident last fall and spent more than three months comatose at St. Anthony Central Hospital in Denver. I flew from Japan within 48 hours of the accident to join my family at her bedside, and was in Colorado for four months straight.
My sister and I divided family responsibilities with her staying home to care for our younger siblings while I stayed near the hospital to meet with doctors, pay bills, and such. What an eye opener.
Can you guess the cost of the entire ordeal? Almost $2 million. The stack of invoices was delivered to me across the billing counter with a straight face. "OK, Mr. Kelly," the secretary said as her fingers flew across the ten-key by her side, "that comes to a total of one million nine hundred and eighty-four thousand dollars, please."
"I see," I replied. "Good thing I brought both of my check books."
Then she said, "Next time you should just say your last name is 'Enriquez' and that you're from Juarez. We have a special stamp for that. Nullifies the charges. You just walk out the door."
I just walked out the door, anyway, wondering how surreal the situation could become. When will the healthcare industry understand that nobody can afford its prices anymore? The situation is to the point that hospitals don't even expect to be paid. Hospital charges are in an entirely separate currency, "hospital dollars" instead of the "street dollars" that people use every day. Unfortunately, there's no way of exchanging one for the other. Currently, a hospital dollar is worth about 1/100 of a street dollar. Hence, what should have cost my family $20,000 ended up costing $2 million.
Apparently, SiCKO is waking a lot of people up to the idea of there being other ways to care for ourselves. Insurance companies and medical development groups need to find some way besides surreal pricing to make their profits. Michael Moore is correct that the profit motive is destroying American health care, and it's embarrassing.
Here in Japan, by contrast, the city where I live sent me a postcard thanking me for paying my taxes and offering me a complimentary physical exam. All I had to do was go to any certified health provider, present the postcard, and receive my check-up. Even as a foreigner, I received that care.
Isn't it time that America took care of its people in similar style? To hell with the lobbyists and insurance fat cats. Put the health back in health care. The current system is best described as "Wealth Care," and it's obvious whose wealth is being cared for.
Japan's Free Trains Today's common Japan question: "Is it true that foreigners can ride Japan's trains for free?"
No.
This myth began because some dishonest foreigners do ride the trains for free. Even people who've been here a long time, know Japan well, and speak the language will sometimes feign ignorance at the train station. The Japanese station worker almost never speaks English, and is simply eager to get rid of the problem.
He asks, "Where from?" as in, "Where did you ride from?" The foreigner then says the name of a train station that's one or two stops back instead of the thirty stops and three train changes back where he actually started. The station worker charges a dollar or two for the short hop, and the foreigner exits the station with a nearly free train ride.
That's not possible on some express trains nor any bullet train because a conductor comes through the cars and checks tickets, but it's easy to do on local trains.
Sometimes, foreigners won't even bother with the ignorance game. They'll just walk through the exit gates to the sound of the alarm bells and keep walking, knowing full well that few station workers will stop a foreigner because of the language barrier.
Tomorrow: A little more on Apple, the state of Starbucks, and Power Investor software.
