Google’s Incredible Strategy

There are many reasons to ignore Google. It sports a market capitalization of nearly $400 billion. The desktop search market is largely saturated. The company appears to be unfocused and has cast its net into areas (energy, robotics, fiber, automated vehicles, hot air balloons, home appliances, wearables, contact lenses) well outside of its core competency. It makes acquisition after acquisition, often times shuttering products or services soon after they are acquired. It’s taken every step possible to ensure the two founders have complete control of the company. More concerning, the founders appear to be running the company as the world’s largest science lab, leaving investors to wonder as precious capital is deployed into a multitude of moonshot projects. It is criticized by many as being an evil corporation.

But, hidden within all the noise are incredible plans. This is a company that tries to see 10-20 years in the future and build products in anticipation of what will unfold. A decade ago, the company began building and acquiring web services. This was during a time when most people thought the consumer internet was dead. Most of these services were quite pedestrian to start, but today have warped into best-in-class services which billions of people use. Maps, docs, e-mail, calendar, Picasa, YouTube, Chrome web browser, finance, news, notes, hangouts/voice, cloud storage, and books. These products are in most instances the best web apps you will find in their category. The services are so powerful that Google has convinced many consumers to purchase a new type of computing device, the Chromebook, which runs only web services and no desktop applications.  The Chromebook is a taste of the future.  Every single person who is on-line uses one of Google’s products. And the best part – they are free.

What Google wants is data. It is a hardcore data science company. And it gets reams of data from the billions of people using these web services, including search, on a daily basis. Google is constantly learning how we interact with the web, our PCs, our surroundings, and with one another, and uses this data to provide better and better services. It’s a wonderful positive feedback loop: better services → more users → more data → machine learning → better services. These products have changed the way we live in many ways and have made us a lot more productive. And, by the way, it allows Google to send us highly targeted ads.

Larry Page visited Africa in the early 2000s and found that most people he met hadn’t heard of Google. He instantly recognized that most Africans were more likely to purchase a connected mobile phone than a connected PC. This led to the acquisition of Android in 2004 and the beginning of Google’s important mobile strategy. Android is yet another product which Google provides for free; in fact, it is open source, meaning any developer can download the source code and modify it to his or her liking. Android’s explosive growth has provided an enormous tailwind for the company. There have been greater than 1 billion Android 30-day device activations to date and this number is surely to grow at a rapid rate in coming years. The mobile phone is an incredibly powerful device – it knows where you are, who you are talking to, how you travel, what information you are seeking and under what circumstances, and how you spend your time 24/7/365. Importantly, newly connected users, namely those in developing economies, will immediately plug into Google’s ecosystem; they won’t have an opportunity or incentive to explore alternatives. What’s the point? More data. The amount of data running through Google’s servers today is almost unimaginable. In fact, no organization on the planet, aside from perhaps intelligence agencies, knows more about us than Google.

I do not think Google is an evil corporation. If you read the founder’s letter and watch the dozens of interviews Larry and Sergey have given over the years, it’s clear that Google is a mission driven organization. The founders and the employees of Google truly want to create products and services that will push humanity forward. Larry Page has, on more than one occasion, mentioned Nikola Tesla as one of his inspirations. Tesla had a number of world changing ideas, but could never convince others to bankroll his seemingly loony projects. Larry and Sergey believe that it’s their mission in life to fund the looniest of projects if it has a chance to change the course for humanity. This is why they want control of the company; they don’t want short-term oriented shareholders derailing their mission.

If Google were to do something evil, it would forever destroy their brand and company. Not many things infuriate people more than a violation of their personal privacy. It’s wildly against Google’s interests to use its data for anything other than enriching its customers’ lives. For these reasons, I don’t have an issue with entrusting my personal information to Google. I believe it will do the right thing and use this data to make my life better. And, I don’t mind advertisements if they are relevant to what I am seeking. Remember the days when we used to buy the paper so we could search the classifieds? Imagine getting information on exactly what you are looking for at the exact moment you want it. I think that’s where we are heading.

As for the moonshots, there’s a group of incredibly bright people behind the Google X and ATAP projects. And the concept is quite brilliant. As was revealed in the excellent Fortune piece, Google Goes DARPA, the company tends to make a number of small bets on potentially world changing technologies. Importantly, the company quickly shutters projects which don’t show promise. This is the type of thinking and capital prudence which is required to achieve singular outcomes. It only takes one huge success, such as Android, to make the effort worthwhile.

A final point about Google. It is a powerful recruiting machine. Despite its size, it still attracts some of the most talented people in the world. Some names include former DARPA director Regina Dugan, acclaimed futurist Ray Kurzweil, former director of Google’s special projects, Sebastian Thrun, in addition to homegrown talent. Furthermore, top university grads still think of Google as one of the best places to work. Many ex-Google employees have started valuable companies, often benefiting from the education and network provided by Google. This is attractive to new graduates. In today’s world, compensation alone isn’t enough to woo talent. Many large technology companies have the means to pay top dollar for top talent. What attracts people to Google is its mission and culture. It’s a place where creative people can (i) develop and push forward their ideas and (ii) work on projects which will have a widespread impact on humanity. It’s the vision of the company, starting at the top, which attracts incredibly talented individuals.


We Should Pay Attention To Technology

Many investors, particularly those in the “value” camp (an oxymoron – why give up purchasing power today if you aren’t fully expecting to gain more purchasing power in the future?), avoid the technology sector, particularly consumer technology, because it’s fast changing and extremely difficult to predict. Although it makes complete sense to avoid certain parts of the tech sector, where winners are difficult to choose, it’s critical to be abreast of developments in technology. I thought one of the most important takeaways from Alice Schroeder’s Reddit AMA is the importance of staying on top of technology trends. Gordon Moore’s prediction that we’d experience an exponential outcome in the ratio of computing power / price has certainly come true and has had a dramatic impact throughout the economy. Computer science has been one of the great singularities of mankind.

When Netscape was started in the early 1990s, it cost $20-30 million to get a startup off the ground. Heavy investments were required in computing power, servers, networking equipment, software, and development resources. Serious software companies could not get started without significant venture capital financing. Today, a small team armed with cheap laptops, Amazon Web Services, and a few hundred thousand dollars can build and ship a fully functioning product and quickly scale users. The extreme lowering of entry barriers and sheer number of users available to developers thanks to the mobile revolution and sophisticated distribution platforms, has led to an explosion of disruptive ideas and new applications in software. Software has changed the way we communicate, produce and consume information, procure goods and services, learn, earn a living, and more. Software is embedded in most everything we do in life. In the future, it will surely be a part of everything we do.

We’re not only seeing innovative ideas in the world of bits, but also, as Peter Thiel calls it, the world of atoms. Many industries which were thought to be impenetrable are now showing cracks. The automobile industry is being disrupted by a battery company, Tesla. The utility business is under threat from distributed power including solar (pioneered by SolarCity) and solid oxide fuel cells (Bloom Energy). Even the food industry is being targeted. A company called Unreal Candy has launched healthy, but tasty, candy products in a direct attack on Mars, Inc. Soylent is trying to change the way we consume food. Udacity, Coursera, and Khan Academy have challenged traditional methods of education.

As investors in businesses, we need to continuously evaluate the strength of a company’s competitive position and to understand potential threats. It’s worthwhile to read publications such as PandoDaily, Techcrunch, and ReCode to see which types of companies are being funded and what the big four technology companies (Amazon, Apple, Google, and Facebook) are doing. These businesses are led by visionary management teams and are increasingly venturing into areas outside their core competency.

It’s only a matter of time before heavily regulated sectors of the economy (energy, healthcare, education), which are widely thought of as having formidable entry barriers, are disrupted by better solutions.

The Power of Influencers

The game of investing is largely a game of developing insights.  The same goes for entrepreneurship.  Peter Thiel’s favorite question to entrepreneurs and job candidates is: tell me something that is true that nobody agrees with?  This really gets one thinking – this is an extremely difficult exercise.  In the markets, even if you thoroughly understand the business, have a good idea of true long term earnings power, and admire management, you won’t achieve a greater than mediocre outcome if your views are undifferentiated.  The market is akin to a pari-mutuel betting system in that the best businesses, recognized as such by a swathe of market participants, will command the highest valuations.  This is why business (and investing) are extremely difficult activities.  In the absence of idiosyncratic events which might create investment opportunities in our favorite businesses, we need to develop other tools to uncover opportunities.

One model I’ve recently been thinking about is the power of influencers.  Influencers are people who command authority, are respected and admired by a great many, and others want to connect to and through.  This is why the endorsement business is as big as it is and getting larger and seemingly more ludicrous every year.  Nike’s recent decision to top Under Armour’s $275 million shoe deal offer to Kevin Durant with a $300 million offer of their own sounds extreme, but is it?  Looking back, Nike’s $90 million deal with LeBron James in 2003, before he had played a single game of professional basketball, also appeared to be egregious, but turned out to be an extremely shrewd maneuver.  The truth is, people are heavily influenced by authority figures and by their peers.  These marketing tactics work by capitalizing on a number of psychological tendencies humans are susceptible to, including authority bias, mere association effects, and social proof tendency.  Kevin Durant’s face in Nike commercials and extensive marketing campaigns in China, a burgeoning basketball market, will likely generate a lot more than $300 million in profits for Nike over the next ten years. Moreover, Nike will continue to build brand strength and thwart a very able and potentially dangerous competitor (Under Armour) from breaking into the basketball shoe market, where Nike has a whopping 93% market share.  It was a necessary defensive play.

In the linkfest I recently put up, I referred to this PandoDaily article, which I found to be particularly insightful.  The first delusion Rick Lewis discusses, “I wouldn’t use it,” is a filter many investors use to dismiss an opportunity.  I think the same delusion applies to people’s view on the effectiveness of advertising.  Most people will tell you that TV commercials, Google text ads, magazine print ads, and billboards have no impact on their purchasing decisions.  Consequently, many people dismiss the powerful benefits of advertising.  If that’s the case, however, why is it that the advertising industry has existed in various forms since ancient times? Why is it a $650 billion+ market worldwide?  Why have many small businesses around the world doubled or tripled revenues by advertising on Google? Advertising works, that’s why.  Buffett recognized the power of advertising early in his career when he got into the newspaper business.  On one hand, the Buffalo News and Washington Post printed money selling ads, supporting many local businesses in their metropolitan areas.  On the other hand, the Nebraska Furniture Mart and GEICO spent millions on advertising to increase business and build their brand. Today, GEICO spends greater than $1 billion annually on advertising. How many people do you know who (i) don’t recognize the GEICO brand, and (ii) don’t associate GEICO with low cost?  The image that GEICO has imbued in consumers’ minds is a powerful competitive advantage.  We certainly don’t think of Progressive the same way we think of GEICO, even though both companies have very similar product offerings.  In many industries, advertising is a weapon businesses can utilize to break out of a competitive pack or expand a lead.

A recent deal which I found intriguing was Apple’s $3.2 billion purchase of Beats Audio.  How could a company selling a purely commodity product in a viciously competitive market achieve such a singular outcome?  Technology reviewer, Marques Brownlee, who I think is the best technology product reviewer in the world (and is a 20 year old college student to boot), laid out the truth behind Beats Audio in this video.  Beats has an astounding 64% market share in the premium headphones ($100+) segment.  What’s more interesting is that they obtained market dominance despite having a vastly inferior product to competing solutions.  It brings to light the power of influencers and saavy marketing.  Dr. Dre, a leading authority in the music business, is the face of the brand.  In addition, the company gets many musicians (and athletes, actors, etc.) to promote Beats’ products in music videos, during live performances, at sporting events, during press conferences, and in public venues. Beats pays some of these celebrities to endorse their product, but also gives thousands of free products to key influencers. When people see not only an authority figure like Dr. Dre, but all their favorite musicians wearing a specific brand of headphones, it gives instant credibility and brand recognition to the product.  Beats also does an excellent job with the design aesthetic of its headphones and unequivocally has the best product packaging in the industry, a la Apple.  Beats products have a ton of sex appeal and trigger lust in the same way Apple products do.  Beats is not an engineering company, it’s a marketing company.  It’s fascinating that a marketing focused company has been able to crush all the sophisticated engineering companies in the space.  The best product does not always win.

If I had an opportunity to invest in Beats Audio five years ago, I could provide 20 logical reasons for why it would be a horrible investment.  But, it wasn’t. It’s the same reason that Jessica Alba’s company, The Honest Company, recently raised a round of funding at a $1 billion valuation.  The company has strong brand recognition, particularly among affluent, health conscious mothers, because of Mrs. Alba.

Think of what makes Twitter such a valuable property.  It’s a business which takes extreme advantage of authority bias.  We humans are very interested in (i) what our peers are doing / saying (Facebook), and (ii) what the people we respect, admire, and are intrigued by are doing / saying (Twitter). Twitter is the only platform in the world where we can get inside the minds of the people who we are innately curious about, but otherwise have no access to.  And it’s a platform where influencers can build their brand and communicate with the people who are interested in what they have to say.  Once we are exposed to these platforms, it’s very difficult to break away because of our natural psychological tendencies.  They are extremely habit forming.

Final thought: one of my favorite case studies is Prof. Bakshi’s lecture on Relaxo Footwear.  It’s another example of how a commodity business operating in an industry with historically horrible economics has built a durable competitive advantage and provided outsized returns for shareholders.  The lecture can be viewed here.

We should be cognizant of the powerful psychological effects caused by authority and social proof bias.  One thing I’m currently trying to better understand is why Bajaj Almond Oil hair drops has a 60%+ market share in India.  I suspect that some of these psychological factors could be at play in this case.

Links: September 3, 2014

Once in a while, I will link to long form articles and stories which I’ve found to be interesting.  The links will focus mostly on business news, but I will also link to worthy pieces of investigative journalism.  I think most of what we read on the internet is poorly researched, poorly written, and mostly noise, but as with any field, there are a number of outstanding publications which put out insightful pieces.  In the near future, I will share some thoughts on how not to get drowned in the world’s sea of information.

  • Costco: CEO Craig Jelinek Leads the Cheapest and Happiest Company in the World (Businessweek) – an outstanding profile of one of Charlie Munger’s favorite companies; it’s interesting that a bricks and mortar retailer can sell goods for lower prices than Amazon while paying its employees $20 per hour; Costco earns nearly 0% margin on retail goods
  • The Four Delusions That Cost VCs Money (PandoDaily) – very interesting take on errors of omission in investing by an esteemed early stage investor; some key models to gaining insights into potentially valuable investments that most others would overlook; the GoPro snippet was particularly revealing
  • Kobe Bryant’s Twilight Saga (SI) – inside the mind of Kobe Bryant, an obsessive compulsive who has spent his entire life practicing the art of continuous self-improvement; my favorite part: “determined to eclipse the Bee Gees, [Michael] Jackson began listening to Saturday Night Fever over and over; such was his obsession that for two years straight, Jackson told friends, he listened to the album 10 times a day, until he knew every note, every beat; until he’d internalized it, deciphered its magic and taken it for his own”
  • GMO Factory: Monsanto’s High Tech Plans to Feed the World (Businessweek) and Seeds of Doubt (The New Yorker) – two very detailed pieces on GMOs and Monsanto’s role in the food production industry; both sides of the argument are presented well; the Businessweek piece highlights how sophisticated a technology company Monsanto really is and how misunderstood the important role it has played in society has been
  • Google Goes DARPA (Fortune) – inside one of Google’s special projects divisions
  • Winnebago Rolls Again (Fortune) – the incredible comeback story of an iconic American company which many left for dead 5 years ago

The Perils of Diversification

The more I study and observe success and failure in life, the more I realize how important focus is.  Our system encourages breadth over depth, trial over commitment, and activity over patience.  The average middle class kid spends her childhood engaging in a slew of extracurricular activities, from ballet to soccer to music to martial arts.  Kids are dragged from one activity to the next and become dizzied by the flurry of activity and wide ranging options available to them. Some activities are dropped for others and most are given up after partial pursuit.  Then, once school begins, she will spend the next 15 years taking general education courses, acquiring much knowledge which will soon be lost due to use-it-or-lose-it tendency, only to have to learn a new set of skills once she enters the workforce. Along the way, she will meet many people and devote substantial time to dozens of relationships.  In the end, however, only a handful will turn out to be truly meaningful.  She unfortunately will have spent too much time nurturing vacuous relationships, and too little time impacting the lives of those who truly love her. One of the most powerful things we can control in life is how we choose to spend our time, and we often spend too much time on activities which are unlikely to have a long term positive impact on us.

In short, we diversify too much.  Rather than engaging kids in 10 different activities, why not quickly narrow it down to 1 or 2 and have them dedicate substantial time to it?  Instead of exposing our youth to a torrent of general education courses, why not encourage them to specialize earlier in life?  Importantly, why not create a set of filters for the people we want to associate with early on and stay true to those filters as we move through life? Contrary to popular belief, much of life follows a power law distribution – a few things account for most of the value.  The one skill we have which we are more adept at than most others, the hobby or side pursuit (e.g. playing a musical instrument) which brings much meaning to our lives, and the spouse or the two key friends who help us through tough times and make us a better human being.

There’s no hard and fast rule and there certainly are examples of well rounded individuals achieving singularity in their lives. It’s in our very nature to explore, learn, and experience as many things as we possibly can.  Charlie Munger espouses worldly wisdom and learning the basic tenets from all the academic disciplines. I’m not suggesting we tune out the knowledge of the world, I’m only suggesting we develop better filters so we can spend more time pursuing high impact activities. We should spend some time learning the basic principles from the various academic disciplines for it will make us better thinkers and decision makers; these principles, however, can be learned and internalized through focused effort, and don’t require 15 years of general education in the format provided by our school system. These concepts should be presented as a broader thinking toolkit, and not learned rote for the sake of passing exams.

From my observations, however, it’s the people who choose a very few things to focus on and pursue it with rigor, determination, and commitment, that are able to make the most of their potential and have the highest level of satisfaction in life.  What they are able to do better than anyone else is say “no”, tune out the world, and engage whole heartedly in deliberate practice of the craft they are trying to master. Rather than trying to do a little bit of a lot, we should be doing a lot of a little. It’s more likely to give us a sense of accomplishment at the end of our lives.

I believe this theory extends to portfolio management as well.  Most portfolios also follow a power law.  There just isn’t enough time nor are there enough opportunities in the market to develop 15-20 unique insights in a given year.  We’re lucky if we are able to find more than a few.  What has distinguished the great money managers from average ones is their willingness to bet big when the odds are in their favor.