The Worldwide Advertising Market in 2011

IDC projects that the worldwide advertising market will grow to over $780 billion by 2011. Of this total, 13.6% ($100-$110 billion) will consist of Internet advertising. These figures, according to IDC's press release, imply a 15-20% annual growth rate in Internet advertising spend over the next three to four years.

Assuming that search holds steady at roughly 40% of the Internet advertising market, this projection implies that Google could continue to grow at double-digit rates for the next few years just by maintaining market share in its core business of search-based Internet advertising.

The U.S. Advertising Market in 2007

Spending on advertising in the U.S. totalled roughly $150 to $200 billion in 2007.

Of this total, roughly $20 billion was spent on Internet advertising.

Within Internet advertising, the three largest categories were search (roughly $8 billion), display ads (roughly $4 billion), and classifieds (roughly $3 billion).

The information in this post comes from two sources: TNS Media Intelligence and IAB. Note that TNS does not include search in its internet advertising total.

Google's Investments in its Core Business

Google continues to invest heavily in its core business, organically and by acquiring businesses.

Google's 70-20-10 model dictates that 70% of the company's time and resources will be devoted to the core business. A reading of Google's open job listings provides further evidence of this priority: Google continues to recruit people to build its advertising business, to improve and further popularize every aspect of its search user experience, and to improve its technology.

Many of Google's acquisitions helped to build or reinforce the three dimensions of Google's core business. For example: Doubleclick, Sprinks, and Applied Semantics reinforced advertising. Several smaller acquisitions (Outride, Kaltix) provided some contribution to search--although this aspect of Google's business was almost entirely developed internally. And acquisitions such as YouTube added new technology capabilities, including privileged access to a tremendous library of video.

Google's Core Business

Google's core business can be summarized in three words: advertising, search, technology.



Advertising provides 99% of Google's revenues. The AdWords program, which provides the bulk of Google's advertising revenues, lets advertisers pay Google to display their ads on Google's search results pages. The (considerably smaller) AdSense program enables Google to display these same ads on third party websites, sharing the advertising revenue with the third-party website owners.

Search is the key service that Google provides to its users. Search delivers the "eyeballs" that view the advertising. Google's brand and its user relationships are built around this service.

Technology is Google's core competency. Google's technology includes the people who work for Google, the software they develop, the hardware infrastructure they operate, and the data they index.

Drivers of Google's Future Revenue Growth

What major factors will influence the future growth of Google's revenues?

• Growth of the advertising market
• Increased share of online advertising as part of the overall advertising market
• [Extension of Google's business into offline advertising]
  
• Increased share of search-based advertising as part of online advertising
• [Extension of Google's business into non-search-based online advertising]
• Increase in Google's share of online searches
• Increase in Google's ability to monetize online searches relative to its competitors
• [Extension of Google's business into non-advertising businesses]

Any of these drivers can be considered, say, by country or by industry.

Google's Market Share

Google's U.S. Market Share

The Core Search Report from comScore measures competitive share of online searches. In July 2008, by this measure, Google had 62% share of U.S. searches. Google's relative market share was 3.0 times that of Yahoo!, Google's closest competitor.

IDC tracks online advertising spending. IDC's report for 2007 indicates that Google had 24% market share of online advertising dollars in 2007. Another report from IDC gives Google's market share of U.S. online advertising as 32.5%, representing a relative market share of 2.0 (twice that of Yahoo!, Google's closest competitor by this metric as well).


Google's European Market Share

European market share (of searches) is also available from comScore. These statistics show that Google has a dominant market position: Google's 79% market share is roughly 25 times the size of its nearest competitor, eBay. These results are supported by individual country data sources. For example, Hitwise indicates that Google has 87% market share of search in the UK, the largest online advertising market in Europe.

A detailed study by IAB and PriceWaterhouseCoopers found that search comprised roughly 45% of the overall European online advertising market in 2006. This would imply Google had 45% * 80% = roughly 36% share of European online advertising dollars. (Assuming the 45% proportion continued through 2008, that Google's advertising revenues are entirely driven by search and that Google monetized its searches as effectively as its competitors did.)

Google Revenue Mix (Domestic vs International)

Google's geographic revenue mix has steadily shifted from domestic to international. International revenue now comprises 52% of the total.

Google Revenue Mix (Line of Business)

Google's revenue consists almost entirely of advertising revenue. The remainder (roughly one percent) includes licensing and "other" revenue.

Google Revenue Seasonality

Google's revenue growth has a clear seasonal pattern: growth is highest in the December quarter.

Google Revenue Trends

Google has continued to increase revenues every quarter since the IPO. In March 2008, Google's revenues exceeded $5 billion for the first time.

Seven Categories of Software

After looking at all the major RDBMS companies and the entirety of their businesses, I'm ready to expand my working definition of the "software industry" and its major elements.

Consider four categories of "general purpose" software:

1. Software that companies use (example: SAP's R/3)
2. Software that individuals use (example: Microsoft Word)
3. Software that entertains people (example: Guitar Hero)
4. Software that makes other software work (example: VMware's products)

And three categories of "specialized" software

1. Custom software (example: Accenture's consulting engagements)
2. Embedded software (example: Boeing's avionics systems for its aircraft)
3. Proprietary software (example: D.E. Shaw's trading algorithms)

A software company may participate in one or more of these categories. By my initial count, Microsoft participates in five of these categories, IBM in four, Oracle in three, SAP in two, and Activision in one.

This categorization may help with industry analysis in several ways.

First, the cost structures of companies within each category may be fairly similar, whereas the cost structures of companies across categories may be radically different.

Second, the marketing strategies of companies within each category may be fairly similar, whereas the marketing strategies of companies across companies may be radically different.

Third, each category of software is likely to exhibit its own unique business trends. For example, "software that individuals use" has been undergoing a major shift from consumer-pays to advertiser-pays, thanks mainly to Google. Another trend in this category is for businesses to adopt personal software to improve the way their employees interact with each other, with their suppliers, and with their customers.

Fourth, the answer to "what does it take to succeed?" may bear similarities within each category but differences across categories.

Fifth, this categorization provides a language for describing and analyzing the strategies of companies who participate in multiple categories. For example, it allows the assertion, "Company X believes that to be successful in Category Y, it must also participate in Category Z." Or, "Company A believes that it must grow beyond Category B in order to be successful, and the most attractive avenue is Category C".

Microsoft's RDBMS Strategy

Microsoft describes their overall company strategy in terms of technology and opportunities, and Microsoft sees SQL Server and Access (their main RDBMS products) in this light.

Unlike IBM, however, Microsoft has not clearly defined its target customer base, articulated its sources of competitive advantage, or provided a compelling reason to understand why it will be successful in the future. Moreover, Microsoft's strategy is so open-ended that it is hard to see what the strategy does not include.

Business and Product Development Strategy. Innovation is a key factor affecting Microsoft’s growth. Our model for growth is based on broad adoption of innovation, willingness to enter new markets, and embracing and acting on disruptive trends. We continue our long-term commitment to research and development, including advanced work aimed at innovations, in a wide spectrum of technologies, tools, and platforms; communication and collaboration; information access and organization; entertainment; business and e-commerce; and devices. Increasingly, we are taking a global approach to innovation. While our main research and development facilities are located in Redmond, Washington, we also operate research facilities in other parts of the United States and around the world, including China, Canada, Denmark, England, India, Ireland, and Israel. This global approach will help us remain competitive in local markets and attract top talent wherever it resides.

Based on our broad focus on innovation and long-term approach to new markets, we see the following key opportunities for growth:

Consumer technology. To build on our strength in the consumer marketplace with Windows Vista, the 2007 Microsoft Office System, Xbox 360, Microsoft Windows Live, Windows Mobile, and Zune, we are focused on delivering products that we believe are compelling and cutting edge in terms of design as well as features and functionality. To succeed in consumer technologies, we also are working to define the next era of consumer electronics. In the past, consumer electronics was a hardware-centric business; today, the innovation in consumer electronics devices lies in the software that powers them. This is creating new opportunities for us to deliver end-to-end experiences.

Software plus services. Underlying our opportunities in consumer technologies, and in all of our businesses, is a company-wide commitment to fully embrace software plus services. The ability to combine the power of desktop and server software with the reach of the Internet represents an opportunity across every one of our businesses. As we continue to build out our services platform, we will bring a broad range of new products and service offerings to market that target the needs of large enterprises, small and medium-sized businesses, and consumers.

Expanding our presence on the desktop and server. While we enjoyed success in fiscal year 2007 with the launches of Windows Vista and the 2007 Microsoft Office System, we see potential for growth by delivering more value per customer. With the planned releases in fiscal year 2008 of Windows Server 2008, SQL Server 2008, and Visual Studio 2008, and the possibility to provide additional value in security, messaging, systems management, and collaboration, we believe we are well-positioned to build on our strength with businesses of all sizes. We will continue to pursue new opportunities in high performance computing, unified communications, healthcare, and business intelligence. Emerging markets are also an important opportunity for us. In fiscal year 2007, we announced the expansion of our Unlimited Potential program as the foundation for our efforts to reach the five billion people around the globe who do not have access to PCs and digital technology today.

Source: Microsoft 2007 Form 10-K, pp. 8-9

IBM's RDBMS Strategy

Oracle is, at heart, a database company. IBM is not. Relational databases form a relatively small fraction of IBM's overall revenue:


Sources: IDC, Company 10-K Filings and Annual Reports. Backup

IBM sees relational databases as one component of a strategy that emphasizes large and complicated IT solutions for business customers:

The company’s strategy is to focus on the high-growth, high-value segments of the IT industry. The company’s broad capabilities include services, software, hardware, fundamental research, financing and the component technologies used to build larger systems. These global capabilities are combined to provide business insight and solutions in the enterprise computing space.

Source: IBM 2006 Annual Report, p. 12

If relational database systems commoditize enough, I wouldn't be surprised to see IBM jettison its proprietary RDBMS business. IBM has demonstrated a willingness to prune its business portfolio, by spinning off or selling businesses that don't fit the above strategy.

The Acquisition Candy Store, Part 2

Oracle's three-year series of acquisitions, including most recently BEA Systems, appears to be the implementation of a "downstream" vertical integration strategy.

The underlying rationale (or "investment hypothesis") for this strategy might follow a chain of thought such as:

1. Oracle's core business, historically, has been the development and sales of relational database systems.



2. Oracle has attained an outstanding competitive position in the RDBMS market by excelling at its software development and sales processes.



3. Although the RDBMS market continues to grow, the market's growth has been slowing. Consequently there is less need and less opportunity to reinvest in the core business and instead Oracle now finds itself with a surplus of cash.



4. More alarming, Oracle's ability to grow profitably in the core RDBMS market is at risk. Open source and lower priced competitive products threaten to commoditize the database technology, eroding Oracle's pricing power in its core business.



5. There are no obvious ways to reinvigorate the core business, and so Oracle's best opportunity to continue growing is to find a "business adjacency" with greater profit potential than the core.



6. Oracle sees "downstream" vertical integration as the most logical business adjacency to pursue. Specifically, the enterprise applications software that runs on Oracle's databases, and the middleware that interconnects Oracle's databases with other corporate systems.



7. Oracle believes it is better to dominate the enterprise and middleware segments than to just participate selectively. (Perhaps Oracle believes there is value in being a single-point-of-contact vendor, or Oracle wants to create larger closed systems, or maybe Larry Ellison just wants to win here as badly as he wanted to win in RDBMS).



8. Acquisitions are a much more effective way to enter this segment than internal software development. A number of high-quality companies had already staked out positions in enterprise software and middleware, and it would be much faster and easier to acquire them than for Oracle to attempt to develop alternative products themselves.



9. Oracle therefore has launched a campaign to identify and acquire best-in-class software companies in all aspects of enterprise software and middleware.

Viewed in this light, Oracle's acquisition spree seems to make very good sense.

But it raises some questions as well.

To what extent is Oracle integrating its acquired companies into a common corporate structure and culture, or to what extent is Oracle continuing to let each one exist on its own? What value is Oracle adding to these companies by being their parent? Will customers prefer the one-stop-shopping approach that Oracle essentially will be offering, as opposed to selecting products from multiple vendors? How much do these moves threaten Oracle's other business partners, against whom Oracle is now competing more directly? Will Oracle be able to maintain the pace of technological innovation in its acquired companies, or will these businesses become less competitive?

All topics for a later time.

The Acquisition Candy Store, Part 1

I once had a conversation with a software company executive about capital allocation. Like many successful companies, his company was generating cash hand-over-fist. As part of his job, he recommended major capital allocation decisions.

We talked about the various options they had, and a little bit on how he thought about the returns on investment for internal projects versus business acquisitions.

Then I naively asked, "What about when you don't have any good reinvestment opportunities? Do you ever look at the return on investment of share repurchases, or even on paying a dividend and letting your shareholders reinvest somewhere else?" (You see, back in the Old Economy, where I work, we actually ask ourselves questions like this. Our shareholders ask us this too. A lot.)

Well, he gave me a look that blended the most profound, heartfelt feelings of sorrow, pity and regret. As if his hope for having an intelligent conversation with me had been cruelly and abruptly extinguished. His smile and enthusiasm collapsed. You poor, misguided fool, his features seemed to say. Did you really believe that crap they taught you in business school?

Needless to say, I found a way to change the subject. But it left me wondering...is there something about big, successful software companies that compels them to want to keep all the cash they generate, rather than give it back to their shareholders?

Now the executive I talked with most definitely did not work for Oracle, but Oracle might be a good illustration of this particular behavior. ORCL is certainly a reliable cash generator:



And, starting in 2004-2005, Oracle went on a tremendous spending spree. Not just the big name acquisitions, but a number of smaller companies as well. Look what happened to their goodwill line:



What was Oracle's software strategy here? Were these dozens of acquisitions made to support their business strategy, or were they seen as the most sensible way to keep the cash in the family?

Will TopCoder shift the balance of power from employers to programmers?

One of the things you learn behind the scenes at business school is that there are two ways to make a lot of money (not counting winning the lottery or being born into the right family!). The first way is the "business leader" route...you can start a company or be a top executive, preferably a CEO. The second way is the "talented expert" route...you can excel at a measurable skill that someone is willing to pay a lot of money for. For MBA's, this used to mean investment banking. These days it more often means hedge funds or private equity.

The "talented expert" route to wealth appears in many different fields. The top NFL players make more than the owners. The top actors make more than the studio executives. The top hedge fund managers make more than the CEOs of investment banks. (IIRC, this phenomenon was documented in The Winner Take All Society).

Aside from several highly publicized Google poachings from Microsoft, we haven't seen as much of this happening in the software industry. Most of the top talent in software development is hidden. It's difficult for any one talented programmer to prove to the market or to an employer that he or she is worth ten times the compensation of another, less talented programmer.

And that's how it has always been, until TopCoder came along.

TopCoder is transforming the world of software development in more ways than one. Not only is it assembling a massive virtual network of programmers from around the world, it is also providing objective, quantifiable ratings of their skill levels and demonstrable evidence of how they work together in teams.

Think about this. The balance of power may be shifting more toward the talent and away from the employers.

Thank you to Judith Hurwitz's Weblog for prompting this thought. And thank you to TopCoder as well, where I have been an occasional competitor since 2005 using the handle JRR.

RDBMS Market Share

Three vendors, Oracle, IBM and Microsoft, control over 80% of the relational database market today, and the same three have led the industry for at least the past decade.



The above chart is based on press releases from or quoting Gartner Group/Dataquest. For specific references see the backup spreadsheet. Note that up until 2004, Gartner/Dataquest only included new license fees in its market data, then began including subscription and renewal fees in 2005. So the data for 2005-2006 is not strictly comparable with the data for previous years.

The shift in mix from 2004 to 2005 because of the reporting change also implies a difference in the major vendors' business models. The fact that Oracle "gains" share and IBM "loses" share when renewal and subscription revenues are added in implies that renewals and subscriptions are a more important part of Oracle's business than of IBM's. (Or, perhaps, that Oracle is consistently willing to lowball IBM on up-front fees in order to make the sale!)

RDBMS Market Size and Growth

The relational database market grew from about $10 billion in 1998 to about $16 billion in 2006, a compound annual growth rate of 7%.

The market research firms IDC and Gartner Group publish annual reports on the size of the market and the shares of the major participants. The latest IDC report costs $4,500, and the Gartner reports are also far from inexpensive, but the two firms do provide some free highlights in their press releases. Oracle has also republished certain IDC statistics. Using this information, it is possible to piece together a picture of the market's size and growth:



These figures include revenues from new installations, as well as renewal and subscription revenue for existing installations. In prior years, Gartner (under the name Dataquest, a market research firm that Gartner acquired in 1995) would typically emphasize only the new installation revenue, whereas IDC would typically emphasize the combined revenues.

This chart also suggests that the tech crash had a relatively modest effect on the database vendors' revenues. Yes, they all had to cope with a flat to slightly shrinking market rather than a growing market, but as industry contractions go, this one appears fairly mild peak-to-trough compared with, say, network equipment or basic materials. The market plateaued during 2001-2003 (the dip in 2003 may be an artifact of how this chart was assembled from IDC and Gartner data; the actual bottom more likely occurred in 2002), but by 2004 the market had reached a new record high.