Buffett has famously said that one useful way to think about a business’s moat – its durable competitive advantage – is to imagine that you had unlimited resources to attack it. If you still could not topple it, you would have found a business with a solid moat.
In Google’s case, this isn’t a hypothetical. Microsoft has spent billions of dollars in a determined effort to put a dent in Google’s moat. So far, all they have to show for it is heavy losses and only modest market share. It is believed that a large part of Bing’s market share has come at the expense of search engines other than Google. Microsoft was recently embarrassed when Google discovered that it was copying Google’s search results.
Charlie Munger had this to say about Google’s moat. “Google has a huge new moat. In fact I’ve probably never seen such a wide moat.”
It’s useful to think about Google’s moat the way you would think about the moat of a dominant city newspaper in the pre-Internet era.
NEWSPAPERS – THE READER’S PERSPECTIVE
For readers, the newspaper was the only game in town for keeping up with local news and an essential tool for buying a car, getting a job, learning about retail sales events, and an almost limitless number of niche activities. Reading the paper was also quintessentially habit forming: pleasurable, repeated daily and low cost.
If you use the Internet, Google is a basic essential tool. Its value lies in letting you navigate the Internet in a rational fashion, whether you’re looking to buy a new camera or need to know the capital of Uzbekistan. This value grows as more information is placed on line – something that is happening at a dizzying pace – and as Google’s search algorithm improves. Google is maniacally focused on improving its search engine and it benefits from having by far the largest number of searches to analyze and learn from.
It tells you something about a company when the company’s name becomes a verb that is synonymous with the underlying function it performs. Could you “xerox” that for me? Google has this kind of mind share.
If you’re Bing, you can’t attack by lowering the price to customers. Google is free. At one point, Bing even tried paying people to search. There is no easy lever to disrupt the habit of going to Google each day to navigate the web.
NEWSPAPERS – THE ADVERTISER’S PERSPECTIVE
If you were an advertiser – auto dealer, employer, department store, furniture store, pretty much any local business – you needed to advertise in the newspaper because you had to be in front of your customers and that was the only cost effective way to do it. The newspaper set the rate and you paid it. Period.
Google is a must-have outlet for advertisers given its 65% share of U.S. search. Its share is much higher in many international markets. Advertisers not only pay for advertising but also work hard to optimize their sites so they show up at the top of searches on important key words. A recent tweak in Google’s search algorithm showed the lengths that companies will go to rise in the search rankings. A company can see it’s sales materially reduced if it falls in the rankings.
Google’s advertising is superior to that of traditional media because it is targeted and the results can be quantified. More value means happier advertisers. That rates are set by auction helps mitigate accusations of monopolistic price gauging which were frequently heard in the “old days” from newspaper advertisers.
A dominant daily newspaper’s growth was constrained by the development of the local economy. Google is not constrained by local geography and is riding two huge secular waves: the transfer of advertising dollars to the Internet and the ever increasing adoption and usage of the Internet.
Regulatory risks swirl around Google but the threat to its core search business seems remote. Because Google’s business is based on technology, there is a some risk of disruption from creative destruction. However, Google is determined to stay ahead in search and it has plenty of cash to purchase start-ups with a better idea.
Recent price: 524.20
Cash per share: 113.00
Cash adjusted price: 411.20
2012 consensus EPS estimate: 39.91
2012 cash adjusted earnings yield: 9.7%