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The Latest Installment of Tech’s Game of Thrones

· October 23, 2014

For tech industry watchers, a recent narrative has emerged that involves Amazon and Google evolving into head-on competitors.  Although this iteration of the narrative is new, the plot is merely a variation on a common theme: two Internet giants who started in different markets evolve quickly into fierce competitors.  (In fact, the Economist devoted a feature article to this phenomenon a few years ago, aptly named “Another Game of Thrones”).  The most famous recent example of this is Google and Apple in the mobile space, where Google’s former CEO, and now its Chairman, Eric Schmidt was booted off of Apple’s board after the two companies quickly morphed into fierce rivals.

Schmidt features in this story as well, as he — to the surprise of many — identified Amazon as Google’s biggest rival in a recent speech:

Many people think our main competition is Bing or Yahoo. But, really, our biggest search competitor is Amazon. People don’t think of Amazon as search, but if you are looking for something to buy, you are more often than not looking for it on Amazon. They are obviously more focused on the commerce side of the equation, but, at their roots, they are answering users’ questions and searches, just as we are.

It is helpful to look back at the origin stories of the two companies to understand how they are evolving.  When Google was founded in 1998, the number of websites on the World Wide Web was just starting to climb up the exponential growth curve.  At that time web search engines were relatively dumb (and “portal focused”) and one of the biggest Internet problems was how to find websites that had information that users were looking for.  Google set about revolutionizing the search space.  It also presented Google with its business model: if it could build a better search tool, it could also use the same insights behind that search tool to serve up more relevant ads to users.  The more relevant the ad, the more useful the ad would be to advertisers and the more they would be willing to pay for it.

Amazon, on the other hand, was founded to tackle a different problem with the early web.  The potential for the Internet to change how people shop was readily apparent (even to the U.S. government), but the logistical problems were immense.  A company needed grand ambitions, if its goal was to scale to such a size where shopping online would present a feasible alternative to running to the nearest big box store.  Skepticism about the security of exchanging financial information online was one of many 800-pound gorillas in the room; another was the daunting prospect of streamlining backend IT and warehouse technology to work efficiently at such a scale.  On top of that, the cost of shipping items around the country would be an added cost that its brick and mortar competitors did not have to bear.

Both Google and Amazon eventually managed to succeed mightily in their original tasks, and the insights and the expertise acquired through those tasks opened up new business prospects for those companies.  Insights Google gleaned on how to direct users to the websites they were looking for led the company to tackle a more daunting task: providing users with more complete answers to what they were seeking.  Users were searching for websites as a proxy for what they were really seeking: answers and information.  Google realized its future would lie in constantly innovating to provide its users answers directly.  With the ascendency of mobile, this task became even more imperative, as mobile users are less inclined to navigate through other websites to get information they need.  The rise of mobile apps offered tangible proof of this phenomenon.

As Amazon scaled to provide a viable online shopping solution, the technologies the company developed to streamline that process proved to be valuable business ventures in and of themselves; the most prominent example being Amazon Web Services.  Managing the world’s largest online inventory required Amazon to develop a powerful cloud computing platform that could manage running the world’s largest inventory in conjunction with one of world’s most trafficked websites.  Complicating matters more, that IT capacity needed the ability to rapidly scale depending on varying patterns of shopping based on fluctuating demand (e.g., Christmas shopping).  Amazon realized that if it could offer other companies these same tools, it could evolve beyond being a mere online retailer to a leader of the cloud computing revolution, which would assure its relevancy and growth well into the future.  To make a long story short, the company succeeded.

The Collision Course

Recently, there have been a plethora of articles detailing how Amazon and Google are going after each other’s core businesses (e.g., here, here, and here).  Google is expanding into shopping and even following Amazon’s lead on building delivery drones.  Amazon, for its part, is developing its own online advertising network, which has the added benefit of knowing what consumers actually have interest in buying (information that Google does its best to approximate) and it has also been reported that Google is more concerned about Amazon’s prospects of displacing it in search than it is concerned about its more direct competitors, Microsoft Bing and Yahoo.  Currently, according to Forrester research, almost one-third of consumers begin their research for purchases on Amazon, which is more than twice as many as Google.  Given that this purchasing information is the holy grail for online advertisers, it is not surprising that Amazon might want to use this advantage and build it out into a broader search and advertising platform.  As one digital advertising veteran put it:

Amazon knows a lot about how people are searching on the site and consumer preferences and histories. It can use that to tailor advertising in ways that probably nobody else can.

Why is Amazon interested in this? First of all, as the WSJ notes, with the companies becoming more aggressive competitors on several fronts, Amazon does not want to give Google valuable information about its customers.  This is why Amazon booted Google from placing ads on Amazon’s site.  (As recently as two years ago, Amazon was Google AdWord’s second biggest customer.)  Second, and more importantly, online advertising is a higher margin business.  For all Amazon’s success in online commerce, it is a low-margin business.  The physical infrastructure and cutthroat competition from other web retailers means that Amazon’s margins are small, especially compared to other major “Internet” companies (and it has certainly taken grief from industry analysts on this).  Increasing margins through innovation and expansion is certainly more preferable for Amazon than raising prices on its core offerings (which would undercut its competitive advantages and make Amazon more vulnerable to disruption, as Jeff Bezos has pointed out).

So, what is Google’s interest in moving into Amazon’s territory?  If online retailing and the delivery of products is a low-margin business, why wouldn’t Google focus its R&D efforts on another market that doesn’t have such a formidable competitor in it?  Google needs to innovate to survive as well.  If Google could get even a small slice of the online retailing market, the information and expertise it gleans from that will help it innovate in its core market of providing users better answers and advertisers more lucrative ad targeting.  On account of the declining marginal utility of data, Google can partially neutralize much of Amazon’s advantage over Google on this front with a fraction of the retail traffic.  Eric Schmidt hinted at this dynamic in his speech when talking about how Google was able to leapfrog Yahoo even though it started out with a fraction of the “data” that Yahoo had originally:

We hear similar network-effect arguments being made about data. Our experience is that you don’t need data to compete online. When Google started, Yahoo was the biggest player in search by a long way. We used just a little bit of data to figure out how to answer queries in a far better way. Or look at social. We had the most popular social network in Brazil. It was called Orkut, and it had many millions of very active users. But in just a few years, Orkut was overtaken by Facebook, just as Facebook overtook MySpace. It’s the recipe that matters the most, not the ingredients.

This is also a reason why one should be skeptical of arguments made that say major Internet companies are traditional monopolies, especially when those arguments are premised on the “network effects” of data.  Even though a company may be the dominant player in a narrow segment Internet commerce, the prospect of competition from non-traditional rivals has fierce disciplinary effects.  Traditional monopolies don’t have margins of less than one percent or significantly “eroding margins” on their core businesses.

On the Horizon

Lest industry observers become fixated on Google and Amazon slugging it out, it is important to remember that other players have the potential to evolve into fierce competitors of both of them.  Even though Google leads in general purpose search, there are inherent limits to information gleaned from most search traffic.  There is not much commercially relevant data to obtain from many searches.  And, even when there is, predicting what consumers might be interested in buying from general purpose searches is inherently problematic.  As discussed, this is the advantage that Amazon seeks to exploit because it — more than any other company — know what consumers are actually buying.  But that is not the end of this story.

Companies like Yelp and TripAdvisor are growing rapidly because they are offering commercially valuable “verticals” (i.e. tools that provide valuable information about a subset of related topics like restaurants or travel destinations).  A search for a trip or a restaurant is much more likely to lead to commercial consumption than most searches on Google.  And, more and more, consumers are navigating to these sites directly (or through the companies’ mobile apps) for that information rather than going through search engines like Google or Bing.

And much like Amazon is using its unique advantages to challenge Google, Facebook is doing the same thing.  Less than a month ago, Facebook rolled out its newly revamped Atlas ad server, which has advantages over cookie-based ad networks such as Google and Amazon.  Most notably, Facebook can use its identity management system to better target users across different devices — something that cookie-based advertising can’t do.  As the WSJ pointed out recently, this could be a game changer:

Facebook says Atlas is more accurate than Google’s DoubleClick services because Facebook knows the real identities of users who are logged in to the social network as they tap the Internet on different devices. That means the performance of ads served through Atlas can be tracked better across the Internet, whether users are using smartphones, tablets or personal computers.

And let’s not forget about the startups either.  A recent Forbes article, titled “Inside Pinterest: The Coming Ad Colossus that Could Dwarf Twitter and Facebook”, discussed how Pinterest is better positioned than most other Internet companies to capture advertising dollars.

(More than a year ago, Pinterest already accounted for a whopping 23% of social-media referrals to ecommerce sites).  The Forbes article had a good segment that described Pinterest’s natural advantages:

To marketers, Pinterest represents a unique proposition, a new medium of a sort that’s never existed before. One difference is temporal. As [Pinterest’s CEO] Silbermann explains it, Facebook “is about your connections, your past events, your memories.” Users on Facebook volunteer a staggering amount of retrospective information such as birthplace, alma mater and vacations, data the company can use to power its highly targeted ad offerings. Twitter can’t offer that level of detail, which is why its revenue per user, at around $3.50, is only half that of Facebook’s. Twitter’s value remains stuck in the now, promising advertisers a presence in real-time conversations about the World Cup, a presidential election or Orange Is the New Black….

The idea of being able to locate consumers at that delicate moment when browsing becomes shopping has marketers intrigued. “One of the things we’re trying to figure out strategically is how to tap into consumers earlier in the inspiration or planning phase,” says David Doctorow, senior vice president of global marketing at Expedia, one of Pinterest’s charter advertisers. “We don’t have great ways to identify consumers in that part of the journey.”

With that in mind, it’s not surprising that advertisers were desperate to be included in Pinterest’s first beta advertising program.  With more demand than it could satisfy, Pinterest limited its test to 12 advertisers, who gladly paid between $1 and $2 million apiece to be included.  That works out to between $30 and $40 per thousand impressions, which is several times the rate that Facebook commands.

Although advertising is Pinterest’s first targeted revenue stream, Pinterest’s CEO pointed to a future that could directly challenge Amazon’s core business as well:

For now advertising is Pinterest’s only revenue line. But it requires only the tiniest leap to conjure a scenario in which the company acts as middleman for the hundreds of thousands of retailers already showcasing their wares on its platform. “The next step will be how do we make it really easy for you to go out and buy that ring or take that trip,” says Silbermann. This is Amazon’s turf, but Facebook and Twitter have been making incursions, with both companies conducting tests of “Buy” buttons for frictionless shopping. Pinterest, though, has natural advantages in e-commerce, with independent research showing its users are more likely to share product links and make big purchases than users of other social platforms.

The Moral of This Story?

TL;DR.  Competition online is dynamic and the competitive lines blur quickly.  As companies rapidly evolve, they become creative about channeling their unique advantages into new products or different ways of providing consumers value.  Also, you might be buying furniture on Pinterest soon.

Competition

Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.