Financial Performance, Consumer Welfare, And Two-Sided Internet Markets

Nearly two years ago in a ConsumerGram entitled “Facts About Financial Power in Web-Centric Companies,” we presented selected data on market structure and performance by major firms in the “Internet Value Cluster” that combine to create joint value for Internet users.  We concluded:  “By fair reckoning all of these Web sub-markets are marked by intense rivalry between very large firms for market share.  In that light, well-informed consumers following the debate are left to wonder why and how their interests are served by imposing government controls on the prices and services of some of these Internet giants and not others.”  This ConsumerGram updates and supplements the earlier analysis.   

 

 

Debate over an array of Net Neutrality issues continues unabated and shows little sign of convergence of views.  All parties are sympathetic to concerns about “openness,” “fairness,” “neutrality,” “discrimination,” “blocking” and others.  But many analysts are hard-pressed to articulate precisely what the debate is really about.  Cynics (perhaps) suggest:  “It’s all about the money!” 

 

Financial Performance Indicators for

Selected Web-Centric and other Companies

 

 

Market

Cap

($B)

 

Sales

($B)

Profit

Margin

(%)

Sales Growth

(%)

Return on

Invested

Capital

 

Return on Equity

 

Return on Assets

Price

To Cash Flow

Price to Earnings

(P/E) Ratio

Google

$183 B

$18.1 B

24.9 %

42.5 %

20.5 %

21.1 %

18.9 %

33X

41X

Yahoo!

37

7.1

6.9

8.7

4.5

12.5

3.9

29X

34X

eBay

41

8.1

5.3

24.0

3.6

3.8

3.0

39X

100X

Amazon

31

16.0

3.2

37.1

24.6

55.7

10.7

40X

63X

 

 

 

 

 

 

 

 

 

 

Comcast

65

31.9

7.7

13.5

2.4

6.0

2.2

7X

27X

Time Warner

58

46.7

7.8

2.1

3.1

6.1

2.1

7X

16X

 

 

 

 

 

 

 

 

 

 

AT&T

233

120.7

10.4

6.1

5.4

11.1

4.6

7X

19X

Verizon

109

94.7

6.0

6.1

4.4

11.4

3.0

5X

19X

 

 

 

 

 

 

 

 

 

 

 

Merck

84

24.3

20.1

6.9

14.4

25.7

10.8

13X

18X

Abbott

83

26.7

14.3

15.0

14.1

23.8

9.9

14X

22X

Bristol Myers

43

20.2

14.2

20.0

15.3

19.5

11.0

11X

21X

 

 

 

 

 

 

 

 

 

 

Exxon

474

434.0

9.72

34.0

23.5

35.6

17.5

9X

11X

      Source: Data retrieved on May 13, 2008 from:   http://moneycentral.msn.com/investor/common/

Financial Performance by Firms in the Internet Value Cluster

The accompanying table was compiled from public data derived from audited books of account.  It allows comparison of financial performance of selected firms in and out of the Web-centric market space:  Google and other applications providers; the two leading cable and telco Internet Service Providers (ISPs); and, for contrast, three pharmaceutical firms and a large oil company.           

 

By commonly used measures of size, market capitalization — the total value of the company’s outstanding stock – Google is nearly five times as big as its principal rival in online search markets; it is larger than the leading cable operators combined; it is larger than Verizon and about 80% the size of AT&T.  Its profit margins, sales growth, return on invested capital, return on equity, and return on assets exceed substantially those of telcos, cable companies and all others in the table. 

 

The value placed by public equity markets on each dollar of the cash flow and earnings of the four applications companies – Google, Yahoo, Amazon, and eBay are substantially above other firms in the table and well above those of the four large ISPs – AT&T, Verizon, TimeWarner Cable and Comcast.  Google stands out here as well.  Its cash flow and earnings multiples are substantially above that for the four large cable and telco ISPs.  Thus, not only are Google’s earnings high and growing rapidly, public capital markets place a very high value on each dollar of them – a sure indicator of investor expectations that Google’s success will continue to outstrip both its peers and the providers of indispensable infrastructure on which Google’s entire value proposition relies. 

 

Google is a very innovative, well-managed, and eminently successful firm.  It has created significant consumer welfare by using and building on the improving capabilities of ISP networks to provide consumers access to growing amounts of information. 

 

Complementarity, Joint Value Creation and the “Internet Value Cluster”

Physical communications network services are complementary to content and applications.  Put differently, networks create value for producers of content and applications – and vice versa.  Reductions in price and availability of one service increases demand for the other, e.g., reductions in the price of printers, computers and networks increase respectively the demand for and value of ink, software and applications/content.  Complementarity occurs when an increase in the quality of one service confers value onto another service – as when the throughput capacity of networks permits faster, more efficient, larger volume transfers of “bits” that enable applications and content providers to provide more diverse and valued services to end users. 

 

Consumers Benefit from Two-Sided Markets

Consumers perceive Internet searches to be free.  There is no direct charge for “Googling.”  Unlike Internet Service Providers and many other firms in the Internet Value Cluster, Google’s revenue comes not from users, but from another set of participants on another side of the marketplace – business advertisers who pay Google for the opportunity to sell “Googlers” goods and services.  Consumers ultimately pay of course, but not directly and not wholly, since online advertising costs are in part reflected in the prices consumers pay for advertised goods. 

 

Google is to be commended for taking advantage of the benefits of “two-sided” markets that permit its costs to be recovered directly from businesses rather than from consumers.  A market is two-sided if the business serves two groups of economic agents, such that the participation of one group creates value for the other.  Google creates value a) for advertisers by selling them the attention and potential sales revenue of consumers who “Google” and b) for consumers who derive value from the outcome of searching. 

 

The two-sided business model appears throughout the economy.  Newspapers, magazines, and cable television recover their costs from both subscribers and advertisers.  Video streaming, text processing software, browsers, videogames, Internet backbones, portals and media, and operating systems are examples in the broad IT space.  The list goes on.    

 

Recovering costs from multiple beneficiaries, as is done by practitioners of two-sided business models, is generally regarded as “consumer-friendly.”  Shifting costs from consumers to businesses in order to upgrade network services and increase bandwidth for consumers would almost invariably increase subscribership, computer ownership and consumer welfare.     

 

In the Internet space, proposals under the general heading of “net neutrality” would deny consumers and businesses alike the benefits of such two-sided arrangements.  While there are many spokespeople for and versions of Net Neutrality, they offer a united front in condemning policy approaches that would permit ISPs to adopt two-sided business models commonly used elsewhere in the Internet Value Cluster.  If used to upgrade network investments and improve Internet speeds, ISPs that adopt such a model to shift some network costs from consumers to applications providers would most certainly increase the network’s value for consumers.  As indicated in a study released last year by ACI, two-sided pricing models would permit lower broadband prices for subscribers.  This in turn would encourage faster diffusion and better service for end users, all of which should create complementary values for all suppliers in the Internet Value Cluster, including Google and its advertisers. 

 

Discussions of the consumer welfare implications of such a scheme are largely, and notably, absent from the debate over regulating Internet Service Providers – a debate that continues to be dominated by exhortations of the value of “neutrality,” “openness,” “nondiscrimination,” “fairness,” and like matters that are impossible to define and largely unexceptionable.  We would urge all participants in the debate, to take a step back and consider the implications for consumers’ economic welfare of the various policy options.

 

 

References: 

1. Financial data taken from:  http://moneycentral.msn.com/investor/common.    

2.  Facts about Financial Power in Web-Centric Companies, ACI ConsumerGram, available at: http://www.aci-citizenresearch.org/ConsumerGram1.pdf .

3.  Larry F. Darby, Consumer Welfare, Capital Formation and Net Neutrality:  Paying for Next Generation Broadband Networks available:  http://www.aci-citizenresearch.org/ACI%20NN%20Final.pdf.

4.  Andre Hagui, “Pricing Structures of Two-Sided Platforms,” RIETI and Harvard Business School (mimeo). http://www.bettermanagement.com/library/library.aspx?l=14019.
5.  Roberto Roson, “Two-Sided Markets: A Tentative Survey Review of Network Economics,” Review of Network Economics, Vol. 4, Issue 2 – June 2005, at p 142.

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