Discover more from Liviam Capital - Finding Reinvestment Moats
An old thesis on Alphabet
I don’t know when I wrote this “thesis” but it was probably 4-5 years ago and long enough ago that Google Cloud Platform didn’t even come into my radar, and I didn’t focus on YouTube, Waymo, or things like capital returns. Given the way optionality has unfolded, it’s possible that Alphabet is an even better business now than it was then. It is very short and a bit crude. I’m not an analyst, so keep that in mind.
Google (now Alphabet) is a phenomenal front-of-mind brand name with an extremely wide-moat business that is able to generate substantial amounts of free cash flows, and should be able to do so far into the future. It’s moat, which can be characterized as impossibly difficult to penetrate, is based around several different, and powerful, models working simultaneously:
Distribution/monetization: The most important thing to know about Google is that it owns 85% of mobile OS market share through Android. This allows it to have the mobile search engine with the widest distribution, and it uses profits from Android to pay for default position on iOS. The same dynamic plays out on desktop, where Google owns Chrome browser which has 67% of the market.
Network effect (1): Advertisers want to quickly and easily place their ads online in front of a large network of consumers. Consumers want to find the advertiser’s products and services quickly and efficiently.
Network effect (2): Google’s search index software is second-to-none, with trillions of pieces of data, gathered over a long period of time, both on the query side and the index side (websites) that cannot be profitably replicated. Customers who want information quickly are able to reliably access this information in fractions of a second.
Customer loyalty: Google provides reliable information to consumers who in turn trust Google to provide them information the next time (Google is equated with the words “find”, “search”, and even “buy” in the subconscious) without much thought from the user.
Pricing power: Google is free to the consumer and therefore it is difficult for competitors to steal market share, short of paying these consumers to switch search engines, or paying larger sums than Google to platforms such as iPhone (for mobile) and Mozilla to make their search engine the default over Google. This would be extremely difficult to do given that Google’s extremely large cash flows. Even if competitors were to pay for placement, consumers may still prefer to use Google because of previous habit.
CPC Pricing: Because Google is the primary form of advertisement for many businesses, to the point of dependency, and because it is an auction based system, CPC tend to generally drift upwards over time reasonably.
Persuasion of clicks: Probably the most important attribute of Google’s moat, in my opinion, is the idea that they can influence where the user clicks, pointing them away from organic clicks toward paid-for advertising. This can be done through a variety of methods including: font size and color, number of ads per page, location of ads, etc. Furthermore, Google search ads are not meaningfully differentiated from organic search results and are extremely relevant, meaning Google does not have to worry about an inferior web experience if they were to devote a larger portion of the page to ads, unlike Facebook and other social media.
Superior return on ad spend: Because people turn to Google with a specific intent to find a product or service, Google’s return on ad spend is far superior to other forms of advertisement, which include old mediums like TV, radio, and print, but also newer platforms like social media, where the user’s primary intent is to socialize with friends and remain engaged with the platform itself. This superior return on ad spend keeps advertisers money in Google’s network even if other opportunities exist.
The market size for Google’s Ad product is large and growing, and again, this is happening in multiple ways:
(1) Google’s ad product is not solely limited to merchants who sell physical goods and thus the market size should not be constrained by the size of online commerce. Google’s AdSense and Youtube products, for example, can be used for general branding purposes of bigger brands like Coca Cola and Disney. Furthermore, Google’s Ad network can also be used to sell non-physical goods such as information, apps, games, and so on. Maps can be used on a local level to drive traffic to stores and restaurants, and all other offline businesses. So, to recap:
Online merchants who use Google for direct response advertising
Brands who use Google for general branding (think Diet Coke, Huggies, Crest toothpaste, Toyota, Disney movies, and so on)
Businesses who sell information, software, services, games, and apps that would fall outside of the umbrella of “online commerce”
Local and offline businesses who use Google to drive awareness and foot traffic
Travel (airlines, hotels, accommodation, etc)
(2) Businesses and marketers are devoting a larger portion of their ad budgets to Google rather than old mediums such as TV, radio, and print.
(3) New businesses and advertisers are more likely to start advertising a product or service with a highly measurable ad platform like Google. The ease of creating an instant ad campaign even promotes the idea that a business can “do it themselves” rather than hire an advertising agency.
(4) The prominence of mobile computing devices such as the iPhone has literally kept Google at users’ fingertips at all times, giving users more opportunities to access Google, and driving more impressions and clicks to ads on Google’s network.
(5) As the outstanding number of websites on the web increases (which is guaranteed), so too will the size of Google’s third party ad network (AdSense), enabling wider distribution of their ad product.
(6) Even if none of the above were to be true, Google would be able to grow their business by extracting more revenue per user by pointing users away from organic search results to paid advertising through one means or another.
(7) Google can still further monetize many of their current platforms like YouTube and Maps and should be able to use their ever-increasing cash flows to invest in creating or purchase new platforms to further distribute their current ad product.
(8) The long-term shift away from brick and mortar to online shopping will continue to push more people to start their search on Google.
(9) Because Google’s ad product is based around textual keyword search, there is no limit to the number of words and phrases that may be advertised. New business names, websites, products, and services will continue to expand the total number of keywords that advertisers will bid on.
I view Google’s leadership as second-to-none. They have displayed time and time again an ability to think extremely long term (think decades). This can be reflected in investments with no apparent short term ROI that have become integral to the business today like Google Maps, Waymo, YouTube, etc.