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As search engines add proprietary content, what are the implications?

Recent announcements have strong implications for the search business:

  • Microsoft announced the full release of its search service today.
  • Google announced that it would offer search of movie scripts and is planning to offer search of books stocked by major libraries.
  • Amazon.com announced that its A9 search engine will offer street-level photographs as part of its local search.
  • Yahoo! announced that in future it will provide its own financial data instead of relying on outside vendors, and will syndicate that data to other web sites.

Here's a quick recap of Amazon's announcement, then a brief discussion of what's going on in the search market and the implications for investors.

Amazon's announcement
Amazon used GPS-enabled trucks to take 20 million street-level digital photographs. They'll be integrated into Amazon's A9 search service, allowing searchers for local businesses to see pictures of buildings next to search results and also to "look around" the neighborhood. Amazon is not the first search company to move into photographs; last year Google acquired a company that provides detailed satellite photos with sufficient resolution for individual buildings.

Search engines add content to become answer engines
On a panel at Majestic Research's December Internet Conference, I predicted that in 2005 the search engines would move to acquire search-relevant content. People at the conference seemed baffled. But here's what we can now see is happening:

  1. Search engines are finding it harder to differentiate themselves purely on the quality of their search algorithms. Yahoo! and Microsoft have largely closed the search-quality gap with Google. They've also abandoned paid inclusion in top search results, because they realize that it reduces their quality and destroys their integrity. (Paid inclusion has also faced legal challenges on the claim that it's misleading and unlabelled advertising.)
  2. The search business is better than anyone predicted. Microsoft and AOL both underestimated the importance and profitability of search. Search benefits from the natural growth of the Internet. One way of looking at this: the search business is the ultimate "user generated content" business. At the same time, the price of pay-per-click (PPC) ads is rising as more businesses establish an online presence, and improved conversion rates boost the return on investment for paid ads. Combine the two, and you find that PPC ad prices are steadily rising, and Google and Overture are sitting on remarkably profitable businesses.

So search engines are looking for ways to take market share. Manages of search businesses are asking themselves how they can improve the quality of their search service and differentiate themselves, if not with the quality of their search algorithms. The obvious answer is to offer proprietary information in their search results that is not available from their competitors. The search engine companies are therefore examining the current and future most popular and lucrative search topics, and are trying to assemble proprietary content that will give them better search results on those topics than their competitors.

What topics are they intially targeting? Local search, because the aggregate e-commerce opportunity is large. (Think about how big the yellow pages business is.) And entertainment, because it's probably the most popular category of search excluding porn. (This explains why Yahoo! is trying to strengthen its access to entertainment content.)

Search engines need to add content for another reason: they are becoming answer engines. Many searches are for information, and customers would be better served by providing answers directly instead of links to answers. Some companies (like GRU's Answers.com) are already doing that, but the problem is that their content is not proprietary. Instead, the successful search engines will add proprietary content that differentiates them from their competitors.

The competitive landscape is changing

  • Amazon is serious about search. Amazon's announcement sends an important message to investors: Amazon is not prepared to see the search market dominated by Yahoo! and Google. Amazon already has access to book content from its book store's "Search Inside the Book" program, and it has valuable customer billing data (including zip codes) that the larger search companies don't have. Amazon badly needs to better monetize its traffic by "virtualizing" its business, as its profit growth has lagged that of higher margin Internet companies like eBay, and its core e-commerce business is coming under increasing pressure from offline retailers moving online and new online discounters like Overstock. Moving into search and comparison shopping would monetize Amazon's traffic and boost its margins.
  • AOL wants to get into the party. AOL also won't sit still. AOL currently has only about 9% of the search market, but its recent launch of search on AOL.com signals that it understands the opportunity. AOL is also well positioned for the transition to answer engines, because of Time Warner's rich library of proprietary content.
  • Microsoft has some proprietary content, and has deep pockets for content/data acquisitions. There's already some speculation that Microsoft will acquire Bloomberg. That would be a smart move. For search companies to make acquisitions of subscription content providers successful, they'll need to tier the information: some should be given away for free to improve and differentiate search results, and some should be billed for on a subscription basis. The key is to segment the two correctly.

The bottom line for investors

  1. Margins for search companies may fall. Amazon added local photos by sending trucks equipped with GPS gear and digital cameras to take 20 million photos. Google plans to scan millions of books. These types of activities involve higher expenses than just tweaking algorithms and selling ads. But lower margins may mean lower valuations for search-related Internet stocks.
  2. Multiples may get hit as GOOG and YHOO move into content. Content acquisitions may make sense for the search engines, but investors may demand lower multiples for converged search/data/media stocks than the current multiples on pure-play search stocks. In other words, if investors believe that Google has to get into the truck business to compete with Amazon's search offering, will Google's stock take a hit?
  3. The competition is heating up for Google. Amazon is serious about search, AOL wants more of the pie, and Yahoo!, MSN and particularly AOL are better positioned to make the transition to answer engines due to their ownership of proprietary content.
  4. Internet investors should be able to make money by spotting acquisition targets before the market gets wind of what's going on. I've purchased stock in one company that I believe has proprietary data that is attractive to search companies. (I've disclosed it in various articles on this blog, but I won't join the dots for you here.) Like many other investors, I'm on the prowl for others.

As always, your comments are appreciated.

Posted by David Jackson on February 1, 2005 at 07:03 AM in Sector Themes, Sub-sector: Search, ticker: AMZN, ticker: GOOG, ticker: TWX, ticker: YHOO | Permalink

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