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— Backstory —
For those curious about where we are on the offline-online continuum, Sanford C. Bernstein & Co. LLC has just weighed in with a report, "U.S. Internet -- The End of the Beginning." And the insights presented in its 310 pages justify, happily, the Churchillian eloquence appropriated for its title. Lead analyst Jeffrey Lindsay and his team remain bullish on the sector, maintaining "an outperform stance on the Internet industry" even as its hypergrowth phase draws to a close. But they establish early on that this assessment is in spite of -- not because of -- industry leadership. "Although the Internet companies often have modern-sounding names for their organization structures, 'the matrix' being the commonest, all of the large players use what is in effect a Soviet-era tractor factory departmental model that would be familiar to Joseph Stalin."
For that reason, the analysts add, the very companies that popular wisdom holds out as most innovative rarely succeed beyond their original breakthrough. "Google, for example, is still dependent upon paid search for more than 90% of its revenues. Its largest innovation to date has been Gmail, which is monetized through paid search." Yet they acknowledge that, in the salad days of cyberspace, management passivity wasn't necessarily debilitating. "In fact," they write, "leaving the business to grow rapidly without interfering was often the best strategy during much of the Internet sector's first decade. "As growth starts to slow, however, management must be much more engaged." The analysts recognize, nonetheless, that Google Inc. and Amazon.com Inc. stand to record near-term growth no matter how they're managed. The reason: "online switching" -- the chance to draw from $600 billion in existing offline advertising budgets in Google's case and from more than $13 trillion in offline retail spending in Amazon's. "It works in a very similar way for both online advertising and e-commerce," they write, "because the dollars are shifting from a large pool -- where the loss of those dollars has a small effect -- into a tiny pool, where the transferred dollars are a much larger proportion of the whole." For advertising, "each 1% of this base that moves online (and to date almost 8% have done so in the U.S.) gives $3 billion in new growth to the U.S. Internet players -- the majority of which still accrues to Google." Then, using the rise of 1950s network television as their precedent, they project online ad growth will be thrice that of offline. So, too, will Amazon's e-commerce operation benefit. "Only about 4% of U.S. retail has actually moved online to date," the analysts report, "but it is the rate at which this small online amount is increasing that gives the e-commerce sector its highly leveraged growth." This means that if total retail sales actually decline, their online component can still show impressive growth. Online shifting is such a force the analysts expect Google and Amazon to "emerge even stronger from the current consolidation phase." And this promises to put more distance between them and the "two weakest performers" they cover -- Yahoo! Inc. and IAC/InterActiveCorp. The analysts note that both laggards are saddled with "the most conglomerate-like structures, which we think makes them least well able to adapt and respond." But they direct insightful digs elsewhere as well. The music business, for instance, is presented as "a case study of how not to manage transition to a potentially disruptive technology." The analysts even blame the major labels for giving the industry away -- "most of it eventually accruing to Apple via the iPod and iTunes service" -- not only by ceding control of online distribution but by chasing revenue gains through higher CD prices. Also exposed is the "pack rat" sensibility of Internet M&A, where assets are frequently acquired but seldom integrated. AOL's acquisitions of Netscape, Tegic and Nullsoft are taken to task, as is Yahoo!'s buying Flickr only to render Yahoo! Photos obsolete. As for the $4.1 billion take-out of Skype Technologies SA by eBay Inc., it's dismissed as a simple mistake. "Unlike their traditional media counterparts who have not had the cover of hyper-growth to obscure pockets of locked-in value to the same extent," the analysts conclude, "Internet management teams have usually been slow to clean house." But they had better start doing so, clearly, or activist shareholders will do it for them. Richard Morgan covers media for The Deal. |
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