THE GOOGLE PHENOMENON
The rapid rise in Google stock since its IPO has led some to suggest it is now overvalued. But Google may deserve it, and more. The company invented a unique and lucrative business model, has few constraints on growth, and continues to be an extremely innovative company relative to peers. And the stock rise is in part attributable to the IPO being underpriced because of investment banks that did not like the way the deal was brought to market.
How long a ride can Apple get from iPod? Because none of the competing MP3 brands has any cache, Apple’s unique ability to make the iPod a powerful fashion statement will help sustain Apple until their next big idea. However, Apple’s attempts with Motorola to make iPod mobile phones are stymied because of conflicts in business models that caused Steve Jobs to call mobile carriers, “the four orifices.” The problem is very simple: the mobile carriers no doubt want to sell the music, not just sell a phone that allows Apple to sell music through the consumer’s desktop computer (thereby leaving the mobile service operator out of the loop). Steve’s statement will make this hill that much harder to climb, but in the meantime he can sell some iPods in China and elsewhere.
The next round of consoles were introduced by Sony, Microsoft, and Nintendo at the May E3 show. Despite enthusiasm for the future, this triggers a negative phase for software publishers. Their R&D costs will increase because of the greater power of the new platforms. Retailers will reduce inventory of the prior platforms. Consumers will now get the message that the older platforms are obsolete and reduce expenditures. Publishers will slash inventory prices and margins will collapse. All of this will occur even before the new platforms are in the market, and when they do arrive, first year hardware sales may restore only 10% of the customer base. In addition, new platforms mean new licensing agreements, and with recent transitions the platform companies have been gaining leverage. Among the software publishers, only EA has any truly “must have” properties (eg, NFL), but even EA will face a big challenge in repeating the favorable terms they had in the past. EA faces other issues, including the recent delay of their Godfather game and challenges in generating revenue in Asia where Western software brands are of less interest and copyright laws are less respected. Historically, these platform transitions have been a death sentence for some publishers and have triggered consolidation moves for others. The recent sale of Eidos is one such example. Eidos had vaingloriously held out for years, rebuffing numerous M&A proposals. This shift is also bad for Nintendo, who is likely to be a distant third in the platform race. Nintendo’s history is as a successful toy and novelty company, not as a technology company. With platforms increasingly like rocket science, the future belongs to Sony and Microsoft. Nintendo has great youth brands and makes great software, but their days as a mainstream box in the living room are nearing an end. They are a much stronger company than Sega ever was, but their migration path may evoke comparisons.
The PC-Internet gaming sector is misunderstood in both directions. The MMO, or “massively multiplayer online game,” is overrated. This phenomenon uniquely occurred in Korea because of Korean reluctance to buy the foreign console formats. This resulted in the Internet café phenomenon, which eventually drove adoption of PCs and broadband in Korean homes and the exporting of the business model to mainland China. The model is also sensible in these markets because there is no content to pirate or copyright to violate. Instead, the client software can be given away because ongoing access to the server is required, and the server can confirm not just payment, but payment on a recurring basis. However, this model will not dominate in Western markets where the gaming market is highly fragmented and users dislike the high subscription fees and demanding gameplay of MMOs. The most successful MMO in the U.S. has an audience of less than 1 million.
Meanwhile, a form of “social community gaming” is underrated. As Yahoo! well knows, the casual web game is alive and well in the U.S. with more than 30,000,000 regular players. Despite the maturity and doldrums of the boxed PC game market, startups like PopCap Games pioneered a web game model that has been highly successful. They sell over the Internet, offering a free downloadable version with a premium fee to download a “deluxe” version. Games like this are very successful on Internet outlets such as AOL, MSN, and Yahoo!. What they demonstrate is that mass market consumers want to be entertained, and they have a need to interact, but not that much. And much more importantly, they want social interaction rather than feeling like they are playing by themselves. Hence we find that a # 1 console game may sell 5,000,000 copies but a far simpler Internet game with less marketing behind it, like NeoPets, can build an audience of 20,000,000. NeoPets was recently sold to Viacom, although we don’t know how well NeoPets “advertising placement” revenue model performs.
3G MOBILE PHONE SERVICES
Hutchison, under the brand name of Three, was the first to introduce higher-speed mobile phone services known as 3G, or “third generation.” Three now operates 3G services in a variety of markets including Hong Kong, the UK, Italy, and Australia. Known by other names such as UMTS and EVDO, these services have been rolled out by other major companies in the last year such as Vodafone, Verizon Wireless, and Sprint PCS. Amp’d, led by the co-founder of Boostmobile, will launch this fall as an MVNO partner of Verizon’s. The theory of these services was premium performance for premium price. But the most successful marketing model has been to court the value-oriented heavy users, because the higher speeds provide more capacity. Both marketing models are being used today, and the sweet spot appears to be early adopters in the youth market. These customers use more voice, more message traffic, and buy more content. While this audience today numbers only about 1% of the world’s 1.5 billion subscribers, the market is growing exponentially and the visibility and word-of-mouth from these users will be critical to developing the mass market.
Another trend in relative infancy is the smartphone, a high-end mobile handset that is replacing the PDA. While a mainstream feature (camera) phone may have $75 in components and 2MB of RAM, a smartphone may have $400 in components and feel like a PDA. To be clear, the smartphone is killing the PDA and has already surpassed its 30 million customer base. Many PDA users will transition to a smartphone, which can do much more and is favored by enterprise users. Smartphones now represent 2% of mobile phones. The format is a notable success in China, where lugging around a garishly large handset establishes a “Cadillac” element of status, even for a middle class housewife who only uses it for voice calls. Nokia and Motorola do particularly well in China because of their quality high-end phones and famous brand names. But for every smartphone sold, there are 10 feature phones sold because of the much lower manufacturing cost and smaller form factor. Most consumers are not enterprise users and most do not want to lug around a larger device. Clearly, the next big handset growth wave will be the Java and Brew-programmable feature phones, which will exceed one billion handsets within another year or so, and exceed two billion handsets perhaps 2-3 years from now. No device in history has ever grown that fast or sold that many. During this same time period, the smartphone will also grow fast and get to milestones like 100 million, 200 million, and so on. Beyond the transition from voice phones to feature phones, the smartphones will eventually come down enough in component cost and miniaturization to become the “next generation” of feature phones. While this is going on, there will be a big battle for OS supremacy on the smartphone. Contenders are Symbian (controlled by Nokia), MS Smartphone (Microsoft), Linux, and Palm. Linux may do surprisingly well, because it is an open platform. Handset makers and operators will not want a dominant standard, so there will be pressure against both Symbian and any Microsoft proposals. But Symbian is today a huge front-runner and even with reduced share may remain the OS leader. These handsets also run other platforms like Java, so publishers of mobile content like Digital Chocolate can easily support smartphones simply by using their Java versions. As for Palm, with the decline in the PDA and only a modest foothold in the smartphone market, the format will face a challenging future.
Content for mobile phones, including ringtones, screensavers, and games, has reached a bit of a speed bump. In the late 1990s, this market suffered from the hype of WAP (wireless access protocol) which never panned out as a major content offering. However, the vision of DoCoMo in Japan and the introduction of camera phones triggered a huge growth phase in content from 2001-2004. Growth has now slowed as Japan and Korea have matured, and other regions have too many customers that are unaware of content or don’t attribute much value to it. One telling example is the European mobile operator whose programmable-Java phone handset market grew last year from 2 million to 6 million subscribers. Most of those users don’t understand the data services, and since there is a minimum monthly fee of 5 Euros, only 200,000 subscribers had signed up. At a tactical level, the market will grow faster as the carriers shift marketing emphasis from voice to data. Previously, the U.S. focus was on voice because in 2003 voice revenue was $85 billion compared to only $2 billion for data services. But despite an absence of marketing, data grew 115% in 2004 to $4.3 billion, while voice grew “only” 15% to $98 billion.
But with voice becoming a commodity that threatens margins, data must be the future. In Japan, data marketing has been strong from the beginning, resulting in perhaps $25 in data ARPU (average revenue per user), compared to $4 in Europe and only $2 in the U.S. Voice ARPU is $50 in first tier markets and this underscores the maturity of voice and the need to grow data marketing, consumer awareness and trial, and hence, revenue.
The history of electronic media helps explain these figures. Content media typically result in consumer spending the equivalent of $3 to $15 in ARPU. By contrast, network media have ARPU equivalents of $30 to $150. What this reveals is that consumers put a modest level of value on entertainment content, whereas they will repeatedly spend 10 times more money to have access to networks that improve their social lives. Mobile voice is one such example, but now it is time to use the data side of the equation to create network software solutions.
Instead of simple downloads of rings and games, what points the way towards this potential is mobile email and instant messaging (IM). While there is nothing wrong with the $4 billion spending on ringtones, when you spread it across several hundred million consumers you get ARPU numbers like the $2 we have in the U.S. But users of the RIM Blackberry are spending $60 in ARPU. And users of IM are generating $5-10 in ARPU. These are network software applications that have social benefit, hence users are willing to pay much more. Notably, even in Japan the ARPU numbers have flattened out because Japan lags in developing and introducing this kind of network social software. There is a great future ahead for a much wider variety of social applications with different themes, including games, blogs, photo sharing, dating, and so on.
MOBILE SOFTWARE COMPANIES
However, RIM (Research in Motion) should be feeling the warmth of numerous red laser dots on their shirt. The Blackberry can attribute its growth to the interoperability of email addresses. With every conceivable competitor wanting a slice of the mobile email pie, this interoperability will become RIM’s Achilles Hell. Because of it, Blackberry lacks “stickiness” and the email market may be carved up among numerous competitors in the future.
Index Corp. in Japan is another high-flying success in mobile software, with a market cap in the vicinity of $2 billion. With a diverse offering of services and revenues in the $300 million per year range, Index may evolve more smoothly than pure mobile content plays like Jamdat or rollups like For-Side and Mforma. Index has higher profit margins and is priced at “only” 6 times revenue run rates. U.S. investors hungry for a mobile pure-play have valued Jamdat at more than $800 million, which is close to 20 times trailing revenue. This phenomenon led For-Side and Cybird of Japan, and Mforma in the U.S., into rollup strategies that may prove hard to operate. Jamdat is also more dependent on content downloads on which they neither control the channel nor own the intellectual property. A desire for continued growth led Jamdat to sacrifice most of their IPO cash in a 15-year license deal for Tetris. If Jamdat can become “the next Index Corp.” then their stock has room for some appreciation. But the current market cap makes their recent success a tough act to follow. As recently as 2003, a rumored EA-Jamdat financing fell apart because of disagreements around a $50 million valuation. The stock has risen 15,600% in the 2 years since. Now, that is a tough act to follow. This may explain the recent rumor that EA was exploring an acquisition of Jamdat, which would give EA an external move to offset their platform transition issues.