Google reported after the bell yesterday, and while the company reported a quarterly profit gain of 17% the numbers were below estimates because of higher costs. The Google results point out two issues that will not only haunt Google but also haunt the whole OTT or “Internet” sector; the limitations of advertising as a revenue stream and the sensitivity of the business model to cost increases.
Early OTT business models were compelling because they were essentially a license to print money. You created a portal, you made it attractive in some way, you placed ads on it for a fee, and you raked in the bucks. “The Internet” was your conduit to the consumer and it was “free”. The problem of course is that any easy model will have a zillion imitators, and you quickly have to differentiate yourself. You also have to address the fact that the potential ad spending you’re competing for isn’t an enormous number. In 2011, for example, online advertising is expected to generate about $30 billion, with search taking about $20 billion. Verizon alone takes in over $100 billion in revenue.
Google under Schmidt was pushing itself to be what the Street wanted, which is the mission of any public company. Google under Page may be trying to be what the Valley wants, the dynamic and exciting company that led the Internet revolution. It’s too late for that, unless you accept that a “Second Revolution” in the Internet has to be one that adapts the players to a more realistic business model, one that allows a better balance of ROI and excitement.
The growing regulatory concern over online privacy is creating yet another threat for the OTT guys. The US and EU have similar regulatory goals but the EU is typically more consumer-protective, and is more likely to do something quickly and advertisers there are pushing ahead with a US-like plan. Anything that limits online tracking limits the relative value of online advertising, and that means that players like Google have less cash to throw at infrastructure of any sort and a greater need for return on what they do spend. Thus, regulatory trends are working against the online giants’ top-line opportunity and also threatening to push their tolerance for incremental spending to open new markets to even lower levels than now. Since “now” sent Google down nearly 6%, that’s bad.
Google’s worries and other near-term earnings stuff aren’t spooking the Street much; while futures are down this morning they’re not collapsing. That’s a good indicator that nobody really wants to bet strongly against the recovery, and also proof that the Street probably doesn’t grasp the details of what the Google trends mean.