April 27, 2004

Valuing Google

John Quiggin writes that Google is (a) an enormous engine creative mammoth consumer surplus (b) for which most of those who benefit from it do not pay a cent, and hence he (c) cannot imagine how it could have a fair market value of $20 billion:

Crooked Timber: How much is Google worth? : According to this report, the widely-predicted Google IPO is likely to value the equity in Google at more than $20 billion - others suggest $25 billion. I immediately wondered whether Google was really worth $25 billion. I started on a standard financial analysis. Although, as a private company, Google doesn’t have to publish annual reports, it’s been estimated that Google has annual revenues of $500 million and profits of $125 million so that the return on equity is about 0.5 per cent. We can expect that to grow reasonably fast in the next few years, but the scope for expansion in Google’s core business is far from limitless. Most people in the developed world are already online and most of the heavy users already use Google (Eszter might have more to say on this). Moreover, there’s no strong reason to suppose that Google will be around in, say, 20 years time. I find it hard to draw a plausible earnings path that would yield a present value of $25 billion at any reasonable discount rate.

That’s a problem for the investors, though. The Google example started me thinking about the more general problem of economic valuation in the Internet era. I started by looking at this piece by Simson Garfinkelhat tip - Tyler Cowen. As well as reporting potential competition from Akamai (relevant in considering Google’s longevity), Garfinkel estimates that Google operates a network of 100 000 servers, but that clever design allows the use of very cheap computers as servers. Let’s and suppose an average of $500 a piece. This implies that the main piece of capital equipment operated by Google is worth around $50 million1 - a hefty sum, but a tiny fraction of the estimated equity value (and presumably there’s some debt in there as well) .

Next, it’s of interest to look at capital-labour ratios. Google apparently has about 1000 employees, which would suggest a total labour cost of the order of $100 million per year - a little on the low side as a proportion of revenues of $500 million, but not implausible. On the other hand, the number of employees is minuscule in relation to the valuation above, which implies a capital stock of $25 million per worker. I feel sure that this kind of ratio would imply some pretty strange organizational policies. Then there’s the question of how much Google is worth in economic terms. I would think the correct answer must be lot more than the present value of its revenues. I use Google all the time, but unless text ads have a subliminal effect for which Google is being paid, I’ve never contributed a penny to its revenues, and quite possibly never will.

The general problem is that, in an economy dominated by public goods, like that of the Internet, there’s no reason to expect any relationship between economic value and capacity to raise revenue. Things of immense social value (this blog, for example!) are given away because there’s no point doing anything else. On the other hand significant profits can be made by those who can find a suitable choke point, even if they haven’t actually contributed anything of value. Assuming for the moment that SCO prevails in its attempts to extract revenue from Linux users, it won’t be because SCO’s code was better than some free alternative but simply because it was widely distributed before anyone found out it was copyrighted. If the Internet continues to grow in economic importance, the central role of public goods in its formation will pose big problems for capitalism, though not necessarily to the benefit of traditional forms of socialism.

I have to agree with all of this. Social value is drifting away from potential profitability, and this threatens to become a huge problem in our collective social resource allocation mechanisms. Google needs to grow to approximately ten times its current profitability and then maintain its market share and margins indefinitely in order to justify the $20 billion valuation. And that's hard to see: high sustained profits are the result of effectively-maintained barriers to competitors--think Microsoft, think Intel. What is going to be Google's counterpart permanent edge?

Posted by DeLong at April 27, 2004 06:42 AM | TrackBack | | Other weblogs commenting on this post

Do the same analysis on EBAY, AMZN, YHOO, ASKJ, MAMA.

None of them are "objectively" worth where their market cap trades at . . .

But thats the peer group Google will step into.

Until Human Beings become rational and unemotional, these aberrational pricings will continue -- which means that inefficeint inappropriate price mechanisms will be with us forever.

That's the reason some people can consistently make money in the market -- finding inappropriately priced equities, and taking positions inopposite those pricings.

The secret is to not trade merely on valuation issues -- there must be some near term catalyst. Otherwise, you would have been short eBay for the last 50 points or so!

Posted by: Barry Ritholtz on April 27, 2004 06:49 AM


Hmmm; you argued (accurately) that inefficient use of capital is essential to capitalism (or at least that is the essence of the defence of Postrel). And this appears to be exactly that.

As a conservative investor, I personally wouldn't go near a Google IPO. But I can only find about 40 stocks that I'm willing to consider outside of the generally-overpriced Dow, and since about half of those are financials (read: takeover plays), I can understand people taking a flyer on this one. It's capitalism in action.

Which is why referring to_Free to Choose_ as _Free to Starve_ is not pejorative.

Posted by: Ken Houghton on April 27, 2004 06:51 AM


Don't forget Red Hat (RHAT). It just keeps rising, even though its core is selling support for open systems. And it doesn't even have a monopoly.

Posted by: tstreet on April 27, 2004 07:53 AM


"Social value is drifting away from potential profitability, and this threatens to become a huge problem in our collective social resource allocation mechanisms. Google needs to grow to approximately ten times its current profitability and then maintain its market share and margins indefinitely in order to justify the $20 billion valuation."


Google is a company with 1000 employees, $500million in revenues and $125million in profits. These are all perfectly healthy numbers for a company valued at (say) $2.5billion.

The only wacky thing about this picture is some greedy investment bankers who think they can convince the public that the company is worth 10 times that much.

Would $2.5 billion be an insufficient capitalization for Google to grow healthily? How about $5 billion? At what point are "we" as a society allocating "enough" capital resources to Google?

Nothing I have read, here or elsewhere, suggests that Google needs to raise $25 billion in order to survive and grow.

Posted by: Jacques Distler on April 27, 2004 07:55 AM


Google is primarily in the web advertising business, not the search-engine business. Mr. Quiggin may say he's never clicked on a Google ad (and these days, that's the only time Google gets paid for ads), but lots of people do. A small-business ad set I have averages about a 1.5% clickthrough rate on its $200/month budget. Those ads cost about as much as two four-line, five-day classified ads in my market and they're many orders of magnitude more effective dollar for dollar than that or any of the targeted direct-mail we do. Mr. Quoggins or not, Google gets a whole lot of revenue from those ascetic little ads, and they've been positioning themselves to get a whole lot more.

When Google ads appear on a third-party site like AOL Search or your blog, thast revenue gets split. When the ad is on a Google-owned property, it's all theirs and the price per click is no different.

That's why Google is only too happy to offer free, increasingly full-featured blogs on its Blogspot property. It's why Google is keen on offering free webmail accounts big enough to be many people's primary mail address and eat Hotmail and Yahoo mail for lunch. They're betting that clickthrough revenue in an average Gmail account over the course of a year is going to be greater than the average revenue derived from all Yahoo and Hotmail accounts, free and paid premium-subscriber combined. They're probably right. Reading email is a whole lot of page views, especially if the account is big enough to be many people's main account.

Google also gets some money from corporate sales of search proucts and from consulting services. Looking at a few of the clickthrough URLs on Froogle, their comparison-shopping service, it looks like they're getting affiliate fees for some of the searches they pass along, no messy contract negotiations necessarily required.

Some of their newer search variants, like the local search and the personalized search return extremely targeted results with tightly targeted ads beside each listing.

They're good. And even though their home pages don't look alike at all, they are indeed a direct competitor of Yahoo's and if I had to bet on which one was going to be bigger in 5 years, I'd say Google, easily.

Does any of this mean they'll merit a market valuation upwards of $20 billion any time soon? Hell no. Are they arguably worth more than Yahoo? Probably, but only if you understand that Yahoo (and Amazon and eBay and..) are overvalued.

Posted by: anonymo on April 27, 2004 08:24 AM


Perhaps the $25b number is after the stock will have flipped several times over in the week following the IPO? (Hmm, past future tense what?)

Posted by: Ng Pheng Siong on April 27, 2004 08:31 AM


<sarcasm>But Professor Delong, aren't profits just so old economy? In America today we have the economics of plenty rather than scarcity!</sarcasm>

Ken's got a point. Technological progress would be great deal slower if there wasn't a stupendous amount of money lost to investors on bad investments.

Think of this less like an economist and more like an anthropologist. Culture is full of ways in which people are suckered into doing things that are not in their best interest but are necessary for the perpetuation of their culture. The glorification of warfare, for instance, or creating a fear of devine retribution if you don't give money to the church. Both have served - at least sometimes - to sustain civilisation. The dot-economy is a way in which the investing class suckers itself into producing social goods that require large capitalisations but have no ready mechanism for generating revenue.

Posted by: Scott Martens on April 27, 2004 08:44 AM


"an enormous engine creative mammoth consumer surplus"

I believe I've gotten spam like this.

Posted by: Chris Marcil on April 27, 2004 08:50 AM


There's an excellent article here ( http://blog.topix.net/archives/000016.html ) that argues that Google's product isn't a search engine; Google's ultimate product is the compute server they had to build to support the search engine.

"Google has taken the last 10 years of systems software research out of university labs, and built their own proprietary, production quality system. What is this platform that Google is building? It's a distributed computing platform that can manage web-scale datasets on 100,000 node server clusters. It includes a petabyte, distributed, fault tolerant filesystem, distributed RPC code, probably network shared memory and process migration. And a datacenter management system which lets a handful of ops engineers effectively run 100,000 servers. Any of these projects could be the sole focus of a startup. "

Posted by: Jonquil on April 27, 2004 08:59 AM


"Social value is drifting away from potential profitability, and this threatens to become a huge problem in our collective social resource allocation mechanisms."

A problem for whom?

Posted by: Handy Fuse on April 27, 2004 09:15 AM


Anyone thinking Google warrants a $20B market cap should read, or re-read, the blog entry of Mark Cuban:

"If the value of a stock is what people will pay for it, then Broadcast.com was fairly valued. We were able to work with Morgan Stanley to create volume around the stock. Volume creates demand. Stocks don’t go up because companies do well or do poorly. Stocks go up and down depending on supply and demand. If a stock is marketed well enough to create more demand from buyers than there are sellers, the stock will go up. What about fundamentals? Fundamentals is a word invented by sellers to find buyers."

Here is the URL:


Posted by: Mike Runge on April 27, 2004 09:38 AM


"Social value is drifting away from potential profitability, and this
threatens to become a huge problem in our collective social resource
allocation mechanisms." Uhh, "drifting away from" and "threatens to
become"? How about "never had anything to do with" and "has always
been". You need to work on tenses. But you're a short step away from
us, "us" being academics in the humanities who still read Marx et al.

Posted by: ecpepper on April 27, 2004 10:02 AM


I will be interested to see how many shares will be sold to the public, or what Google’s “float” is going to be. I’m going to guess at 20%, and if a “$20 billion IPO” means $20 billion is sold to the public, then this company will have a capitalization of $100 billion. Compare that to the market cap of IBM, which is currently $155 billion. On the other hand, if a “$20 billion IPO” means that is the market cap after the offering, then the company will have raised $4 billion of capital with it’s IPO, not $20 or $25 billion.

Short sellers are supposed to correct over valuation, but with a low float, they can’t. They would have to borrow stock to short it and there isn’t enough to borrow. A classic case was Palm. 3Com spun off Palm, but even months after the IPO; the capitalization of Palm exceeded that of 3Com even though 3Com owned about 95% of Palm (5% float). So clearly Palm was way overpriced and remained overpriced for a very long time.

Posted by: A. Zarkov on April 27, 2004 10:05 AM


perhaps Google should have incorporatea as a non-profit. People then could be getting tax writeoffs for advertising on Google.

Posted by: Zizka on April 27, 2004 12:06 PM


Other thoughts on the valuations of Google et al.

1] If you think about it, AMZN and EBAY aren't really in the same category as the rest. AMZN is a retailler with a differentiated business model (just as Wal*Mart was, once). And EBAY is the world's biggest classified ad periodical, with the added advantage of high cash turnover. The other firms are just search engines.

2] Let's look at Google's infrastructure for a second. Quiggan thinks of computer equipment as capital. Wrong model. Computers, in Google's world, are an expense. Every day they probably discard about 2% of their gear, and install 3%, meaning that the number of computers they have will increase slowly over time. But because the power of each computer is doubling every 18 months which means a dailly appreciation of (solve for the series, carry the two) 0.633%, this means that they are growing computer power by 1.663% dailly: more than enough to keep pace with the exponential increase in the web's content.

3] The capital is in the intellectual property of their *software* (and a lot of good-will in the brand - observe how hard it is proving for Microsoft to overcome doubters as to their ability to return 'unbias' search results), not in the machinery. The truly clever thing in Google, the things that delivers their 'value', is the Brin/Sergy 'page rank' technique.

4] Google is not perfect. There is room for innovation in web search. And the barrier to entry is as fragile as a new idea that improves on Google's. Machinery is an expense that an even cleverer architecture than Google's might reduce. As there are a lot more smart people who do not work for Google than there are smart people that work for them, the probability that this 'new idea' will come from somewhere else is very, very high.

In short - SHORT!

Posted by: Paul G. Brown on April 27, 2004 12:18 PM


Couldn't agree more that Google's competetive advantage is its server systems. Its VERY hard to have that much processing power managed so efficently. I work for a major IT company that could not do the same for ten times the cost to save itself from bankruptcy (and that's not exagegerating, major IT projects are really, really hard with staggering failure rates even when they have comparitively easy criteria for success).

Having said that, they probably will be over-valued. I think business's are still just starting to realise that the efficiency and competitiveness of the internet means that you can have a service that is used by almost everyone on the internet, with brand recognition through the roof and still only be worth a couple of billion. There's a viable business there, but not an enormous cash cow. The internet's just too innovative and competitive.

Lastly, I think that going public will destroy Google. Google is popular in large part because of the credibility of its search results. The temptation to increase revenue in the short term by biasing search results in favour of paying customers at the cost of destroying the brand will be too great. Plus to run google's IT infrastructure efficiently will require very high quality management. If they don't have quality management the costs will rapidly blow out. When that cost blowout comes the only solutions the senior managers of the company will have will be to replace themselves with higher quality people to get the costs back down or burn the brand by biasing the search results. Guess which one they'll choose? Management at the board level won't be able to replace the senior managers who bungled the IT because their expertise is in finance. They won't have the knowledge required to judge the performance of the management of IT in Google Inc.

Posted by: still working it out on April 27, 2004 12:52 PM


It's a fundamental contradiction within the internet model, and always has been. Normally utility is paired with purchase value is paired with consumer choice. This is what demand vs supply curves depend upon, the percieved social utility is a function of demand and supply.

The problem with things like google is that demand does not equal supply does not equal consumer purchasing, which breaks down the linkage to percieved social utility.

I use google all the time. I pay nothing for it, essentially. Now google has given me 1000 megs of free storage in gmail. Is that really right?

Posted by: Oldman on April 27, 2004 01:26 PM


Btw I believe this is a Nash / competitive equilibrium situation, essentially a "tragedy of the commons" style scenario. That such things can so commonly exist brings into question the wider assumption of Pareto optimum or Hicks-Kaldor conditions for wider market equilibriums. As the game theorists say, generally the Nash equilibrium is the natural equilibrium for any competitive multiplayer game with no coordination between members. Perfect information and zero sum conditions may or may not be applied to the model.

Posted by: Oldman on April 27, 2004 01:29 PM


Shush. In the presence of unbelievers, the magic won't work. And then where will we be?

Posted by: jam on April 27, 2004 01:49 PM


How is Google going to prevent its competitors from stealing its best engineers - the ones who have designed and now maintain the huge server farm? How is it going to prevent these engineers from leaving and setting up their own start-ups?

Posted by: Michael on April 27, 2004 01:51 PM


"What is going to be Google's counterpart permanent edge?"

They can expand into the Third World for the next 20 years or so, I think. In the long term, maybe they can get to be a public utility.

"Social value is drifting away from potential profitability, and this threatens to become a huge problem in our collective social resource allocation mechanisms."

This sounds very much like an argument Richard Stallman has made for free software. Socialism rulez.

Posted by: Randolph Fritz on April 27, 2004 02:03 PM


because no one can pay them more if the server farms aren't of themselves worth something special.

still, I think the nonsequitor comment at the top has it right. Google is making money. the only reason this IPO is happening is to make employees happy and the VCs rich. if Google were only worth $2 billion (or $200 million, or whatever), it wouldn't matter to anyone but the stockholders.

Posted by: wcw on April 27, 2004 02:04 PM


Just to emphasize one thing Zizka said:

The CAPITAL EVALUATION MUST INCLUDE THE SOFTWARE. Google is an application software broadcaster.

Including only the cheap commodity hardware is completely bass-ackwards. Nevertheless, I absolutely refuse to predict the market capitalization of Google in 10 years. In 5 years it will still be at least popular, and perhaps world-dominant.

It may be that the entire world only needs a dozen or so software companies, of which Microsoft and Google would employ 80% of the total number of software engineers.

Posted by: Warren on April 27, 2004 04:00 PM


Paul G. Brown wrote, "But because the power of each computer is doubling every 18 months..."

Huh? That's a reference to Moore's Law, I assume. But Moore's law has to do with CPUs, and the power of a computer is dependent on a lot more than its CPU speed.

Posted by: liberal on April 27, 2004 04:18 PM


Oldman wrote, "The problem with things like google is that demand does not equal supply does not equal consumer purchasing, which breaks down the linkage to percieved social utility."

What about things like Microsoft? More generally, what about any industry where the fixed costs >> marginal costs?

Posted by: liberal on April 27, 2004 04:22 PM


As a professional trader, (not a broker,) I can say with complete certainty that any attempt to use economics, or even common sense for that matter, to value the price of a stock like Google is useless. Markets are driven solely by psychology - fear and greed. Fundamental analysis is primarily used for either creating that fear and/or greed in order to manufacture a move in a stock, or to justify a move in a stock after the fact. And, in the case of this IPO, the buzz is already all over the street. I am a member of the American Stock Exchange, and we hear about how Google is going to "change the valuations" of Yahoo, EBay, Amazon, etc., on a daily basis. The AMEX is not exactly the apex of Wall Street, so when we hear it, the buzz is pretty pervasive.

My point is that anyone who attempts to use logic and analysis to "prove" that the Google IPO is overpriced is setting themselves up for short-term disappointment. Once the public decides a stock is a buy, there's no analysis in the world that will dissuade the masses from blindly buying up all the stock they can get. Eventually you'll probably be right, but not until all the frenzy has worn down. Google stock trading at 300 times future earnings? Sure. If that's what the buying public wants to pay, then that's the "fair value."

Remember pets.com? The most basic analysis would have told you that company was doomed. Free shipping on a 20lb bag of dog food across the country sold at a discount to market rates? They'd burn through their cash in a matter of months. If you sold short on the IPO, you would have eventually been right. However, you had to wait for the stock to peak first, at over quadruple the IPO price. You would have been out of business long before the stock peaked, even though your analysis was completely correct.

I apologize for the rambling nature of this comment. I just feel it's very important for the public to understand that the stock market does not behave rationally. Well-thought analysis is routinely outshone by gut emotionalism, which is by nature unpredictable.

Posted by: Jason on April 27, 2004 04:50 PM


"Well-thought analysis is routinely outshone by gut emotionalism"

In the short run the market is a voting machine, in the long run it's a weighing machine.

Posted by: richard on April 27, 2004 05:57 PM


Jason: Yes, yes, yes. I was trying to say the same thing, but you said it much better. It was obvious that Palm was overpriced, but that didn’t cool the stock for a long time.

Posted by: A. Zarkov on April 27, 2004 06:06 PM


The famous quote spuriously attributed to Keynes has it about right "The market can stay irrational longer than you can stay solvent".

I've calculated the present value, but I'm *not* suggesting that anyone should short the stock, unless they've got the funds to maintain a short position indefinitely.

Posted by: John Quiggin on April 27, 2004 06:14 PM


Without getting myself into the valuation thing...

Google had to be a lot better than the competition in order to get users to switch to it. It was possible at the time because search results by the major engines often produced pages of ridiculous results and Google was the first engine to fix this situation noticeably. It's not going to be so easy now to push Google out of the lead because 1) everyone including Google has their eye on the same ball now, so nobody is going to have a huge technology advantage, and 2) even if a product was developed which users slightly preferred in a blind comparison, nobody's going to switch this time (New Coke Syndrome). A whole generation or two has associated the catchy name 'Google' with quality search, and has no reason to switch from one free product to another. Word of mouth adoption sure isn't going to happen again like it did with Google. I don't even know if an expensive ad campaign by a competitor would do much.

Posted by: snsterling on April 27, 2004 06:24 PM


This isn't about rationality of valuations. It's about money, specifically the basis of it. Google's valuation is rational with respect to the supply and demand of information. Unfortunately, our money system is based on hard assets - mostly land and that which you can put on top of land.

As our economic system moves more and more away from capital being physical goods that allow low quality labor to make high quality "things", the relationship between the money we have, and what we want to value, will continue to grow more tenuous, until there is a complete meltdown or blow up.

This isn't the first time this has happened. Specifically there have been two major monetary basis changes in recent history.

The most recent was the leaving of the gold standard, and the establishment of an asset standard - which began after world war II and was only really finished by the end of Bretton Woods. But the major shift was the New Deal, which moved the basis of money to lending by banks, backed by the FDIC and regulated by the Fed and SEC.

The previous one was the establishment of the hard gold standard, which began in the early 1800's, but was only really completed in 1870. Each one worked, for a time, because there was an organic relationship between the bottleneck commodities and how much money could be created. This meant that as real economy expanded, so too did money.

For the Gold era it was Gold equal to resource extraction. In an era where finding resources was all, gold is a good proxy for exploitation of resources.

For the Assets era, it was capital development. Assets loaned against in the banking system are a good proxy for how much durable capital is in the system.

Since we are not in the old asset era, what has happened is gradually we have found ways to evade its restrictions, and print alternate currencies to express value. Stock options are one prominent example, derrivatives are another. These represent "free market money". Free market money works, until it doesn't. the problem is that there are incentives to create both artificial scarcity (for example, how much of MS is available on the market?) and artificial abundance - as the dot com boom showed.

When this "alternate currency" system breaks down, there will be a drive to incorporate it into the main monetary system and regulate it. This will be attendant on a constitutional change, which will structure the new form of money in the basic constitutional order.

Posted by: Stirling Newberry on April 27, 2004 06:34 PM


One word. Altavista

Posted by: carl on April 27, 2004 06:52 PM


For liberal:

Strictly speaking, Moore's Law is an observation about how densely transistors can be packed. Less strictly, Moore's Law is a projection of how much computer power can be bought for unit price over time.

In Google's case, their system is built atop a huge number of 'computer bricks', each of which has small, unit cost. So, in 18 months time, they'll be able to buy twice the grunt for the same burn rate.

The broader point is that the capital cost of server computer power is no longer an economic barrier to entry, for anyone. A single new, rogue idea will end 'em.

Posted by: Paul G. Brown on April 27, 2004 08:11 PM


Paul, I think that the criticism is that the raw, per-unit cost of CPU's isn't the major factor in Google's computer set-up. The ability to very cheaply run an array of 100K units is. Therefore, if the price of computers drops by 50%, Google isn't necessarily able to run a 200K unit array for the same price.

Posted by: Barry on April 28, 2004 04:07 AM


snsterling, I see the three major open questions for google, inc. as:

1) *****Microsoft****** (it needs the emphasis), which doesn't need 'better' to win in the marketplace.

2) Better search algorithms. Google currently leads, but the web has taught people to be flexible, and switching is easy. As the web gets more complicated and larger, better searching will become more and more important.

3) Satisfying conflicting demands, as a for-profit concern. Keith Ellis (here or on Crooked Timber) put Google's trick very simply: 'give the user what he wants, and get out of the way'. Uncomplicated screen set-ups, minimal hoops to jump through. As a for-profit public firm, Google, inc. will have to not mess that up, but still be able to draw profits. And if the share prices end up huge, then there will be a lot of pressure to grow earnings very, very quickly.

Posted by: Barry on April 28, 2004 04:13 AM


What is going to be Google's counterpart permanent edge?

If anything, it will be (like Intel and Microsoft) finding a way to make its existing dominance itself a barrier to entry. Their system for delivering relative "sponsored link" ads to third party sites (and, of course, getting some of the ad revenue) is one example of this. The more that takes off -- which, since it uses the same base of "sponsored links" as the ads on their own search sites, is kick-started by their search engines popularity -- the less dependent they are on the current popularity of their search sites with users for revenue, as the base of existing web sites using their ad technology itself encorages people to advertise with them, , which in turn encourages people who want to turn traffic into revenue without the muss of selling ads themselves to turn to Google's system.

Posted by: cmdicely on April 28, 2004 10:04 AM


It is easy for a firm in a fixed cost>>marginal cost industry to recoup costs - they are invariably monopolies or oligopolies. See airlines, most big good manufacturing businesses, Microsoft(development cost=fixed cost), movie studios, etc.

The problem arises when the product is difficult to charge the customer for, no matter fixed or marginal costs. (broadcast, roads, "public" goods, lighthouses being the traditional example)

Broadcast solved it with advertising - you "pay" by watching Bud Light ads. That is Google's model, as well. Other alternatives are "gatekeepers" who charge for access (like cable TV, which provides access to and revenues for cable networks - AOL was the models here in computing), or per time unit usage charges, like Prodigy and Compuserve tried in years past. Also, government/charity takes over some of these, like roads, or library internet access (or, say, the mormons for genealogical content). Google's model is winning for content, the gatekeepers are for access. (Just like cable TV, where there is more content on advertising-revenued channels than "premium" access chargers, but access is priced per month, and nothing is priced per unit used except a very few "pay-per-view" unique events.) These two examples will be heeded by the wise content provider - I suspect $.99 per song or $4.00 per movie download will not be long-run winners in the digital world. And even Blockbuster, the great "per use" renter, is slowly introducing more subscription options, in response to Netflix.

Posted by: rvman on April 28, 2004 02:18 PM


Google is NOT worth 25 billion, by the way. Modern stocks are valued on the greater fool theory. Mark Cuban's explanation as linked by Mark Runge on the 27th at 9:38 am explains it better than I can, from a more reliable source. (Someone who made huge cash from this system.)

Posted by: rvman on April 28, 2004 02:40 PM


Broadcast solved it with advertising - you "pay" by watching Bud Light ads. That is Google's model, as well.

Actually, I'm not convinced it is Google's model, at least not singular, for the long term. Google also sells "Google Search Appliances" for people to use on their own in-house networks, essentially selling the search engine software. Google also acts as an advertising middleman, rather than just selling ads on their own site.

They also seem to laying (in the Google API beta) the infrastructure for letting other people use the central search engine and other Google tools without being exposed to Google search site and advertising by using custom software accessing Google web services, with the basic infrastructure for collecting fees by search volume (currently, its free, and just has user accounts with volume limits, but its an easy transition from that to a model which you pay for search volume).

Posted by: cmdicely on April 28, 2004 03:07 PM


Now that the IPO is scheduled to be for $2.7B, does it make (more) sense?

Posted by: Ken Houghton on April 29, 2004 12:30 PM


Ken, I think the $2.7bn is the amount expected to be raised by the IPO, which typically involves selling around 20 per cent of the equity

The $25 billion would then be obtained by predicting that the stock price will roughly double on the first day, and applying this to the entire equity.

Warning: this is off the top of my head, and I haven't seen the report to which you apparently refer

Posted by: John Quiggin on April 29, 2004 01:21 PM


It's unlikely that Google's stock price will double on the first day. They're planning to do an auction-style IPO, which means that all the bidding up happens before the price is set, rather than afterwards. It's a much better way to do things for the company, since the company gets the money instead of people who are chummy with the underwriters. I'm kind of surprised that they got their underwriters to buy off on it, but I guess they've got a lot of clout.

As for their valuation, after you look at how they account for stock-based compensation, they're tripling in size every year, and modulo stock-based-compensation handwaving, made around 150 million dollars in 2003. Using the "market cap equals profits times profit growth in percent" rule of thumb, you come up with a NPV of 30 billion dollars. It's not completely ludicrous.

My biggest concern is if they'll be able to retain their corporate identity after they become a public company. Their funky voting structure may allow them to do so, but that remains to be seen.

Posted by: Jake McGuire on April 29, 2004 07:32 PM


As a very late footnote to this; Google's "servers" are probably closer to $50 each in price, rather than $500 each. They don't have monitors, which is the most expensive part of a standalone computer, and the Sun people at Google know very well what it costs to build a computer--Sun was, after all, a hardware company and Andy Bechtolscheim was responsible for the SparcStation. I'd guess that energy, especially power for cooling, is Google's biggest operating expense. (Common saying in sales & marketing: "prices have nothing to do with costs." And this is most true in consumer markets.)

Posted by: Randolph Fritz on April 29, 2004 08:25 PM


The capital is in the intellectual property of their *software* (and a lot of good-will in the brand - observe how hard it is proving for Microsoft to overcome doubters as to their ability to return 'unbias' search results), not in the machinery. The truly clever thing in Google, the things that delivers their 'value', is the Brin/Sergy 'page rank' technique.

For what it's worth, search engine optimizer (SEO; it's an entire slightly redolent industry) types seem to be operating under the assumption that page rank is an increasingly small portion of Google's page ranking algorithm. SEOs had figured out how to game page rank by running server farms linking to their target pages (basically Googlebombs writ large).

I looked through the S-1, and the managers are saying all the right things about refusing to damage the brand in favor of short term success, Buffettesque unwillingness to massage the numbers, etc. I have no doubts that the IPO is going to be dramatically overvalued, but I'm not sure it's going to be ludicrously overvalued.

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