Venture capitalist Bill Gurley has another excellent economic analysis of how powerful Android is
and what it really means for Google. I have one (somewhat serious) quibble with it, in that I actually think Gurley misses the key economic point that would have made his argument even more convincing
, but I'll get to that later on. The key points he makes are dead on, and should be recognizable to regular readers of this blog on our economic analysis of zero marginal cost products.
He kicks it off with a general business observation from Warren Buffet:
One of Warren Buffet's most famous quotes is that "In business, I look for economic castles protected by unbreachable 'moats'." An "economic castle" is a great business, and the "unbreachable moat" is the strategy or market dynamic that heightens the barriers-to-entry and makes it difficult or ideally impossible to compete with, or gain access to, the economic castle....
For Google, the economic castle is clearly the search business, augmented by its amazing AdWords monetization framework. Because of its clear network effect, and amazing price optimization (though the customer bidding process), this machine is a monster. Also, because of its far-reaching usage both on and off of Google, AdWords has a volume advantage as well. Perhaps the most telling map with regards to the location of the castle can be found in Jonathan Rosenberg's "Meaning of Open" blog post. In this open manifesto, Jonathan opines over and over again that open systems unquestionably result in the very best solutions for end customers. That is with one exception. "In many cases, most notably our search and ads products, opening up the code would not contribute to these goals and would actually hurt users." As Rodney Dangerfield said in Caddyshack, "It looks good on you, though."
From there, Gurley points out that pretty much all of Google's other products are effectively that "moat." They're the things that keep bringing you back to Google's search and ad products. And that's where Android fits in:
So here is the kicker. Android, as well as Chrome and Chrome OS for that matter, are not "products" in the classic business sense. They have no plan to become their own "economic castles." Rather they are very expensive and very aggressive "moats," funded by the height and magnitude of Google's castle. Google's aim is defensive not offensive. They are not trying to make a profit on Android or Chrome. They want to take any layer that lives between themselves and the consumer and make it free (or even less than free). Because these layers are basically software products with no variable costs, this is a very viable defensive strategy. In essence, they are not just building a moat; Google is also scorching the earth for 250 miles around the outside of the castle to ensure no one can approach it. And best I can tell, they are doing a damn good job of it.
From there, he points out, that this makes it difficult for anyone else "trying to extract economic rent for a competitive product in the same market." Indeed. And while that may raise some antitrust alarm bells, Gurley later points out why it should not:
One might yearn to suggest that there is a market unjust here that should be investigated by some government entity, but let us not forget that the consumer is not harmed here -- in fact far from it. The consumer is getting great software at the cheapest price possible. Free. The consumer might be harmed if this activity were prevented. And as we just suggested above, the market is finally driving towards software pricing that represents "perfect competition."
I actually think there's a decent retort to this, which is that someone could
say that this moat situation means that others cannot get into the market at all, and thus consumers could be hurt in the decrease of competition, which could mean that certain innovations don't make the market and/or that Google begins to stagnate on innovation as it faces no serious competition in those areas. To date, however, I don't believe there's much evidence that this is happening with Google (though, it is an area worth watching carefully).
But, really, what Gurley is describing is the same stuff that we've been talking about for over a decade: it's the natural economics of digital goods. Over time, someone
will figure out a way to price those goods at the marginal cost of zero, and use that to support some other business. So, if you're sitting around hoping to charge for those goods, you're going to be left out in the cold. We know that argument
and live that argument, though it's always nice to see it being validated yet again in real life.
But here's the key point that I think Gurley is missing, and which would have made his argument even stronger. Above, I bolded the line in his writeup that said that "Google's aim is defensive not offensive," with these products. I think he's actually underestimating Google here. These moves are both defensive and
offensive (the best offense is a good defense, right?), though not in the traditional way of trying to directly monetize those
offerings. It's that those "free" or abundant goods don't just act as a defensive shield, but they can also make the scarce "castle" good much more valuable
. If we're sticking with the moat analogy, it's a situation where the moat not only acts as a defense, but it also serves to float the castle to even higher levels
We've described this in other fields many times. For example, in a simplistic example, with music, freeing up the music makes it easier to spread the music, build a bigger fan base, and then increase the value of the scarcities around the musician (so they can make more on tour or through merch or more creative business models).
And I think that's certainly true with Android as well. It doesn't just build a "moat" around Google search/AdWords that protects that business, but it actually enhances
those businesses and makes them more valuable
directly. It does those things by extending the availability and usage of such businesses (I do searches on the go from my phone all the time these days), but also opens up those businesses to scenarios where they never would have been useful before at all.
So I agree with Gurley's basic premise, that making use of such zero marginal cost infinitely available goods by embracing their free nature acts as a very powerful moat, but I think he underestimates how much of an offensive play it is in not just protecting the castle, but vastly enhancing the castle's offensive power as well.