The Rational Walk
Intelligent Investing is not a "Random Walk"

Apple Risks Dominant Position in Tablets With New Digital Publishing Model February 17, 2011

The battle between Apple and Google intensified this week with both companies unveiling long awaited business models for publishers eager to develop recurring revenue sources through sale of tablet based subscriptions.

Apple’s service imposes more onerous terms on publishers compared to Google’s “One Pass” service and severely restricts the information publishers are likely to collect from customers.  For Apple and Google, the stakes in this battle are far higher than developing incremental revenue sources from these digital publications.  The winner is likely to gain dominance in tablet operating systems for the foreseeable future.

Very Different Terms

Apple plans to charge publishers 30 percent of revenue from all sales processed through the App Store which is consistent with the revenue share Apple receives from application developers.  Publishers will be permitted to sell subscriptions to customers through other channels such as the publisher’s website but will be prohibited from offering any discounts to customers who bypass the App Store.  In addition, Apple will not provide any customer data to publishers unless the customer specifically opts in.

Google will take a 10 percent cut of revenues for subscriptions purchased through the “One Pass” service and claims that this revenue is essentially covering its costs for managing the process and not intended to be a profit generator.  Google will also provide customer information to the publisher unless the customer opts out. There is no information to indicate that Google plans to prohibit publishers from offering discounted subscriptions for customers who bypass the One Pass service.

Subscriber Data is Critical for Publishers

While the revenue share is the most obvious difference in terms, the more important restriction imposed by Apple involves the customer data.  There has always been a major distinction between “single copy” sales and subscription sales from a publisher’s perspective.  The customer who picks up a physical copy of The Economist at a news stand is entirely anonymous.  The subscriber to The Economist is always known to the publisher.

Most publishers allow customers to opt out of solicitations for products or services, but the key point is that all publishers use subscriber lists to directly solicit renewals.  By depriving publishers of the customer data, Apple seeks to keep the customer anonymous and increases the probability that future renewals will be processed through the App Store rather than through a direct transaction between the publisher and the subscriber.

Essentially, Apple seeks not only a “finder’s fee” for bringing the subscriber to the publisher in the first place, as is typical with many agency relationships, but aims to develop a recurring revenue stream in which renewals are processed through the App Store.  It is far more likely that this goal is behind Apple’s “opt-in” model for providing customer data to publishers than any idealistic notion of customer privacy.

Window of Opportunity Closing Fast

Apple’s iPad is currently the market leader in terms of market share as well as capabilities but a flood of Android based tablets will appear on the market over the next six months.  If Apple’s current dominance in tablets convinces publishers that they must go along with Apple’s terms, and if Apple can release a competitive iPad 2 this spring, it is very likely that Apple’s dominance can continue.  The main reason is that customers are attracted to the iPad not only because of the hardware and operating system capabilities but because of the content offered by third parties.

Apple must be hoping that enough publishers will agree to make subscription content available within the next few months due to the iPad’s current dominant market share.  When the iPad 2 is released and must compete with newly competitive Android tablets, Apple’s goal should be to not only have the best hardware and software but also the most comprehensive array of publications on the  market.  If this goal is met, Apple’s market share should hold up well because customers will gravitate toward the content.

On the other hand, if Apple has overreached, publishers may decide that it is worth moving forward with Android based tablets in anticipation of much more competitive products coming to market in the near future.  If a larger array of publications are available on Android devices, Apple’s market share will be pressured even if the iPad 2 retains a technological lead over the new generation of Android based tablets.

High Stakes Gamble

Apple may have been better served by offering less onerous terms to publishers particularly related to customer data.  Doing so would virtually guarantee that publishers would gravitate toward the Apple ecosystem due to its current market dominance and would result in the widest possible selection for users.  Apple would still have to retain its technological lead with the iPad 2 given the advances in Android based devices, but it would likely be secure in having a lead in content availability.

The decision to impose harsh business terms on publishers has increased the uncertainty regarding how the tablet wars will play out over the course of 2011 and may help Android based devices gain additional traction.

Disclosure:  No position in Apple or Google.

1 Comment on Apple Risks Dominant Position in Tablets With New Digital Publishing Model

Google’s Inflation Measure May Keep Government Statistics Honest October 12, 2010

There are no perfect solutions when it comes to protecting assets from the ravages of inflation.  While the United States Federal Reserve does not have an official inflation target, government officials are known to favor an inflation rate of at least 2 percent and define such a level as “price stability”.  As a result, the minimum realistic assumption for inflation causes a doubling of the price level over thirty-five years.  The reality could be far worse given the desire of the Fed to flood the system with liquidity through additional quantitative easing which, stripped of technical jargon, basically involves printing currency to purchase government bonds and other securities.

Financial instruments such as I-Bonds and Treasury Inflation Protected Securities (TIPS) are intended to provide inflation protection but the government is in charge of coming up with the official Consumer Price Index (CPI) that supposedly measures the overall price level.  Many skeptics note that governments that allow high rates of inflation often manipulate official measures of inflation.  However, the amount of data available today may make it more difficult for the government to manipulate statistics in the future.

According to the Financial Times, Google is planning to construct a price index that could eventually serve as an alternative to official government statistics.  While the Google Price Index (GPI) is still a work in progress and only tracks web-traded goods, the potential for expansion into other sectors of the economy could provide a more complete picture of inflation in the future.  As the range of goods sold over the internet expands over time to better mirror the overall economy, the GPI should more closely track to the actual inflation experienced by consumers.

For now, the GPI is showing a “very clear deflationary trend” for web traded goods this year and most economists do not see any widespread inflation on the immediate horizon.   However, with Japan as a notable exception, there are few cases where a government in charge of a fiat currency wishes to create inflation and is unable to deliver.

Comments Off on Google’s Inflation Measure May Keep Government Statistics Honest

E-Books Receive Mixed Reviews in the Classroom September 6, 2010

One year is a relatively short period of time but represents an eternity when evaluating the products offered in the nascent market for electronic reading devices.  One year ago, there was much excitement regarding the potential for the Kindle DX to revolutionize the market for textbooks.  The Kindle DX is a larger version of’s popular Kindle device which is more suitable for larger formats such as textbooks.  Several business schools aggressively rolled out materials specifically designed for the Kindle DX.  The results of the experiment are now in and according to the Financial Times, the device has received very mixed reviews.

Lack of Flexibility Cited as Main Limitation

The University of Virginia’s Darden School of Business converted many case studies used in first year classes and selected 62 students and 10 faculty members for a pilot program.  Although students approved of the large screen and ability to reduce the need to carry large amounts of paper, the Kindle did not offer sufficient flexibility in a classroom environment.  Difficulty annotating cases and quickly accessing different documents were cited as major limitations of the device and some students eventually abandoned the Kindle in favor of laptops or paper.  75 to 80 percent of Darden students would not recommend the Kindle DX to incoming students although 90 to 95 percent of respondents did approve of the Kindle as a general purpose personal reading device.

Will iPad Address the Flaws?

This year, the iPad is competing with the Kindle DX for market share among students and others who require a larger reading display.  The smaller Kindle is now aggressively priced at $139 for a Wi-Fi version or $189 for a 3G version.  While the iPad is a more expensive product starting at $499, it also may appeal to students who are attracted by a color display, the availability of thousands of applications, and the many entertainment options that are included with the device. (Students seeking to justify the iPad to parents will no doubt omit reference to the entertainment features of the “must have” iPad device.)

While the iPad is certain to have a major presence on college campuses this fall, it is unclear whether the limitations cited by the Darden students will be addressed.  The attraction of being able to carry large amounts of material in electronic format is the obvious benefit along with better multimedia capabilities.  However, the flexibility of paper for taking notes and quickly referencing information may still have an advantage over the iPad just as it did in comparison with the Kindle DX.

iPad As Laptop Replacement?  Seems Doubtful...

A more interesting question is whether students will be able to use the iPad as a primary computing device and replace laptop systems that have become mainstays of college campus life.  It seems highly unlikely that the iPad will replace the laptop on campus given the need to produce large amounts of written material.  iPad keyboard and docking accessories are available and could allow students to write papers using the device, but the traditional laptop’s form factor and proven capabilities are still superior.  For affluent students, the iPad is more likely to supplement the traditional laptop rather than to replace it.

A year is a very long time in the quickly changing market for tablet style devices.  The fall of 2011 will no doubt have many additional tablet choices for students including products running Google’s Android and Microsoft’s Windows operating systems.  Amazon will continue to move forward as a provider of purpose built reading devices rather than general purpose tablets.  The day may come when students are liberated from dragging textbooks and laptops from class to class but it does not appear that the day has arrived just yet.

Disclosure:  Long Microsoft, No Position in Apple, Google and

Comments Off on E-Books Receive Mixed Reviews in the Classroom

Estimating Global Brand Value April 28, 2010

FT Global Brands Survey

The ability to find businesses with durable economic moats that are available at reasonable prices can mean the difference between consistently superior investment results and mediocrity.  Intuitively, it is obvious that companies with powerful brands will enjoy economic moats that can generate high returns on invested capital on a consistent basis.  However, knowing how much to pay for a brand is difficult because it is not always easy to quantify brand value in a manner that value investors are comfortable with.

The Financial Times published a special report today (also available as a pdf file) that attempts to quantify brand value for the top 100 global brands.  The top global brand remains Google followed by IBM, Apple, and Microsoft.  Coca Cola, McDonalds, and Marlboro are familiar consumer products brands that appear in the top 10 list.  The survey was developed by BrandZ and is based on quantitative consumer research and financial analysis.

How Does the Brand Contribute to Earnings?

The financial model calculates brand value by examining each brand’s ability to generate demand.  The dollar value of each brand is predicted based on future earnings attributable to the brand discounted to present value.  The analysts developed the concept of “brand contribution” to differentiate between earnings that are driven by brand equity versus other factors.

Obviously a great deal of judgment is required to identify earnings that can be attributed to the presence of brand value.  In addition, estimates of future earnings are necessarily imprecise particularly for the brands that are more subject to technological change.  Investors can be nearly certain that brands such as Coca Cola, McDonalds, and Marlboro will provide value decades from now but the same cannot necessarily be true for brands such as Google that represent economic moats that have been formed over a much shorter period of time.

How Durable is the Brand?

The question of brand durability is critical when considering an investment.  In addition, the more an investor pays for brand value, the lower the margin of safety if there is any question regarding brand durability.  For the sake of argument, assume that we accept the BrandZ methodology.  If so, Google’s brand value is estimated to be $114.3 billion while its current market capitalization is approximately $169 billion.  In contrast, BrandZ estimates Coca Cola’s brand value at $68 billion compared to a market capitalization of approximately $123 billion.

The purpose of this observation is not to comment on the valuation or relative attractiveness of Google and Coca Cola but to point out the need for investors to clearly understand that when they pay premiums over tangible assets in order to acquire a brand, it is critical to be able to estimate the durability and earnings power of the brand ten or twenty years from now.

How many of us could have predicted technological marvels like the iPad ten or fifteen years ago?  Maybe some insightful individuals were able to but nearly anyone in 1990 or 1995 could have predicted that people would be drinking Coca Cola and eating at McDonalds in 2010.

Disclosure:  No direct positions in companies mentioned in this article.

Comments Off on Estimating Global Brand Value

Book Review: Inside Larry & Sergey’s Brain February 7, 2010

Inside Larry & Sergey Brain

On January 12, 2010, Google announced that the company would re-evaluate its approach to doing business in China after the discovery of cyber attacks that appeared to target human rights activists.  While Google did not directly accuse the Chinese government of complicity in the attack, the company clearly stated that it is no longer willing to censor search results.  At a time when nearly every major company in the United States is trying to expand opportunities in China, Google has decided to buck the trend with a very controversial move that could result in a major setback for the business.  What could Google’s executives have been thinking when they made a decision that was sure to cause a political uproar?

Richard L. Brandt’s latest book, Inside Larry & Sergey’s Brain, presents a portrait of Larry Page and Sergey Brin that helps the reader understand what may have motivated the company to initially enter China by accepting some level of censorship.  Although the book was published prior to Google’s recent announcement, we can draw some important insights regarding the way Google’s founders think about the issue of doing business in China.  Perhaps more importantly, the book also allows the reader to glimpse into the psyche of the founders and draw some conclusions regarding entrepreneurship in general.  For anyone investing in early stage companies, the insights are invaluable.

Mr. Brandt’s book is not as well known as  Googled:  The End of the World as We Know It which we reviewed in November.  However, one can argue that Mr. Brandt succeeds in providing a more vivid background of both founders and he also makes a better effort to draw links between their core values and a number of decisions that were made which may appear “crazy” at first but actually led to Google’s stunning success.  It is easy to see in retrospect how conventional thinking could have destroyed Google’s ambitions at several points during the  early years.  The fact that Mr. Brin and Mr. Page stuck to their core values made all the difference.

Can Idealism Coexist with Good Business Sense?

Google’s idealism is hardly a well kept secret.  In fact, the idealism of the founders has often been mocked as disingenuous by outside observers.  However, Mr. Brandt clearly shows how Mr. Brin and Mr. Page kept Google on course with an idealistic view of the world that ultimately provided the differentiation required to succeed.

Perhaps the most important example was Google’s insistence to not permit advertisers to purchase ranking in search results and to keep all advertisements clearly distinct from search results.  Google could have easily maximized short term profitability in the early years by taking a less idealistic approach (as all their competitors did).  It must have been incredibly tempting to do so.  The founders did not come from wealthy families and were facing pressure to produce profits.  However, ultimately the decision to consider the needs of the search user first trumped short term profitability but led to the trust required for the company to gain traction in numerous other initiatives.

Pros and Cons of Entering China

Google’s founders struggled with the question of censorship for several years before deciding to accept restrictions in exchange for being permitted to enter China.  Mr. Brandt’s chapter on China asserts that the founders never lost sight of their determination to contribute to positive change within Chinese society.  The question was whether engagement, even with restrictions, could improve the free exchange of information within the country.  Google was the first search engine to insist on at least notifying users if the results of a query were censored.  This fact alone helped to expose the actions of government to restrict the information citizens are permitted to see.

It is difficult to maintain cynicism regarding Google’s intentions for China after the company announced a willingness to exit the country if the government continues to require censorship.  While some subsequent statements made by Google’s CEO Eric Schmidt appeared to soften Google’s stance to some extent, the company seems committed to follow through on the statements made on January 12.  At this point in time, the decision seems likely to cost Google some profits but so did the earlier decision to refuse to allow advertisers to influence search ranking.  Google may be making a long term profit maximizing move if the new policy builds trust in China and the government eventually is forced to back down.

Genius, Hard Work, and Entrepreneurship

Sergey Brin and Larry Page have IQs that are obviously off the charts.  They were also willing to work extremely hard and found a way to start Google with very little capital.  They started out of a garage and used second hand and improvised furniture.  They were able to secure venture capital funding and attracted other talented people to join the company.

But while IQ, hard work, and guts are required elements associated with any successful startup, these attributes alone are not sufficient to ensure success.  Silicon Valley’s history is full of startups that failed despite all of the wonderful qualities that Mr. Brin and Mr. Page brought to Google.  What made Google such a stunning success is what may have been initially viewed by outsiders as insanity on the part of the founders.  However, the unconventional thinking that failed to maximize profitability in the short run directly led to Google’s stunning rise.

Controversy Will Continue

Google will continue to be controversial in the future.  We recently asked whether Google’s recent re-pricing of employee stock options meant that the company’s “Don’t Be Evil” pledge does not apply to stockholders.  Apple CEO Steve Jobs recently declared that Google’s “Don’t Be Evil” mantra is “bullshit”.  Google is often accused of expanding well beyond search particularly with its emphasis on offering applications for cloud computing.  Will the company use dominance over search to gain unfair advantage in new ventures?

Mr. Brandt provides an important service to those who are interested in moving past simplistic sound bites and gaining a better understanding of what makes Sergey Brin and Larry Page tick.  One gets the distinct sense that these men will be rocking the boat in the technology world for decades to come.

Disclosure:  The author of this book review does not have a position in Google. Richard L. Brandt provided The Rational Walk with a copy of his book.

Comments Off on Book Review: Inside Larry & Sergey’s Brain