Google - Growing Up (and a model for Hedge Funds?)

Since last Thursday, Google has made three very interesting announcements which highlight what I believe to be the seeds of a master plan: cementing its power as the portal for information discovery on the internet (horizontal domination), while laying the groundwork and providing incentives for those with domain-specific assets (whether in vertical search, proprietary content, etc.) to play with them (vertical participation). Let me start by saying that the world I see is one in which: (1) Google gets the most out of its generalized search technology and distribution power through legal, above-board deals with value-added content providers, while (2) stitching together powerful vertical search capabilities through either stategic alliances or acquisitions. If successful, what will emerge is a Google that will not only be the dominant portal for generalized search and discovery across the web, but one which will provide much more accurate and relevant search results for those interested in specific areas not well served by generalized search algorithms.

By striking deals with AP and MTV, Google is doing for content distribution what the hedge fund industry should be doing with side-pockets and illiquid asset valuation and compensation - getting out in front of what will only be an increasingly critical PR landscape and re-shaping the dialogue along their own lines. This is pure genius and the benefits of this approach will (hopefully) not be lost among hedge fund managers everywhere.

Content Distribution

Google's deal with AP indicated that they are going to pay something for some manner of content which will serve to complement what currently exists in Google News. Google's deal is certainly notable and potentially has implications for content creators everywhere. While Google bent over backwards to show that this deal in no way went against the "fair use" stance so critical to their business model, it still represents a landmark agreement that will invariably be replicated between the leading news aggregators (like Google News) and a vast array of high-value proprietary content providers. As noted in Friday's Wall Street Journal:

While Google was quick to emphasize that the specific licensing deal with the Associated Press doesn't affect Google News, the deal appears to have been structured so that it satisfies AP's desire to get paid for its content, and at the same time allows Google to maintain its position with respect to "fair use" of content on Google News.

"Most of the big new superpowers on the Web aren't spending any money on content creation," said Jane Seagrave, vice president of new media markets at AP, "and that's what many of us in the traditional media do best. It's a very powerful partnership if you can get the business model right."

I think Jane is right and highlights the specialized skills and distinct competencies between the creators of content (like AP) and the "new media" distributors of content (like Google News). This historic relationship has long existed between content creators and traditional media, and one only need look in print newspapers to see the references to wire services and other non in-house creators of content which look to traditional media as their distribution vehicle.

As I began writing this post last night, I only needed to look at this morning's WSJ and New York Times to discover a new Google content deal: the agreement between Google and MTV relating to video clips and the resulting revenue stream to be shared among Google, MTV and the site owners hosting the videos. Today's article in the NYT indicates that Google appears to be focused on the long-term here, giving Viacom the lion's share of the ad revenues in order to illustrate its growing savvy in dealing with content creators:

The deal may also be a sign that Google is getting better at dealing with the producers of news and entertainment, which have sometimes claimed that Google uses their content without appropriate consent and cooperation.

*******************************************************************

Eric E. Schmidt, Google’s chief executive, said Google would pay a majority of the advertising revenue to Viacom. “The content owners do the work,” Mr. Schmidt said. “Distribution businesses should get a minority” of the advertising revenue, “and the creator should get the majority,” he said.

An executive involved in the deal said Viacom would receive more than two-thirds of the revenue. (The executive spoke on condition of anonymity because the deal terms were confidential.)

By contrast, most of the other companies that are trying to build video advertising networks — including AOL, Brightcove and Revver — are proposing to pay about half of the revenue to the content creator. (Revver, the smallest of them, has agreed to give as much as 70 percent of the revenue to big media companies, said its chief executive, Steven Starr.) Both AOL and Brightcove have other video deals with Viacom and have discussed providing video advertising to it as well, according to executives involved in those negotiations.

Is this a kinder, gentler Google than the one we've seen become a search and advertising behemoth over the past 8 years? No, just a much smarter Google that is looking to feel more comfortable in its own skin as it grows to a size where everything it does will be analyzed and scrutinized to death. Further, continuation of its break-neck growth will also become an issue if it doesn't diversify its revenue bases and build its portfolio of high-value content. What Google doesn't want to have happen is to become another Microsoft, one perceived as a monopolistic, brutal competitor that eventually finds itself on the receiving end of scorn (and litigation) among users, governments and the media.

Search

On Thursday, it was posted on the Google Research blog that Google Research would release of a very powerful set of data (over 1 trillion - yes, trillion - words) and make it available to researchers everywhere. This corpus is particularly relevant for those in the fields of search, statistical text processing and machine language translation. Google Research will make this data available through the Linguistic Data Consortium, so I am assuming they will have a list of those who have requested the 6 DVD "boxed set."

So what of this grand gesture? My guess is that by making this data available, and by knowing which individuals and/or companies have requested this data, that Google will have a line into those doing R&D across areas of interest. This is just so smart. Doing well by doing good, so to speak. If this data helps professors, start-ups, researchers, etc., develop better search and/or translation algorithms and are helped by access to the Google Research data set, it stands to reason that Google would be the logical licensor or acquiror of this intellectual property. Enlightened self-interest is one of the engines of innovation, and Google's actions indicate to me that they have truly internalized this concept.

There is no question that Google has upped its game. The vision and maturity evidenced by these recent actions is impressive.  The calculus of balancing meteoric growth and dominance with good citizenship is extremely hard, but Google has shown that they are up to the challenge. Now if only hedge funds could learn from this example.

Comments

[Roger]

Greg, you are right, what can I say. If my thesis is correct and that the big institutional (and, most importantly, fiduciary) flows will primarily go to those who follow best practices as it relates to valuation, reporting, conflicts of interest, etc., then the market leaders may well find it in their best interest to blaze the trail. However, it is only if the likes of CalPERS, PennSTERS, UTIMCO, Yale and Harvard apply this pressure that change will come about. The leaders certainly won't alter behavior in the absence of enlightened self-interest, and the way this happens is through a very clear quid pro quo - "I give you a nine-figure check, you give me clean, granular numbers, no side pockets monkey-business and all that other crap." Without this, it's business as usual - unless either the SEC or Congress changes the playing field.

[Greg Battle]

Good discussion Roger. The hedge fund PR problem is a structural one as there are legal constraits with regards to marketing/solicitation in the industry. Though your suggestions would seem beneficial, if the industry couldn't put together a unified front against the very real threat of SEC regulation, they certainly won't rally behind the type of self-regulation you suggested. Most funds privately had an opinion on SEC regulation while publicly burried their head in the sand. As for best practices, where do you think aggressive fees, sidepockets, side letters, crazy gating provisions, and prohibitive liquidity constraints came from? The market leaders themselves under guidance from the leading law firms. Leading by example indeed! The only elements that appear to be unified is industry-wide discretion, operating underneath the public's radar, and pushing the boundaries of what investors will endure.
[Just the way I like it!]

[Roger]

We are in fundamental agreement. As noted in much of my earlier writing I am a fan of free markets, with self-regulation emerging from the market's requirements. I do believe, however, that what you feel can't be done by the fragmented HF industry can, in fact, be accomplished. Easy, no. Possible, yes. Worthwhile, I think so. That said, in the absence of industry-wide agreement on the "hot button" issues raised in my post, the larger funds capturing the big institutional dollars will lead the charge in best practices and others will eventually be forced to follow. My belief is that this is the most likely path of how these thorny issues will be addressed. Unfortunately, I think a lot of the PR currency the HF industry could collect through a coordinated effort will be lost. C'est la vie. The HF industry was never much for PR, anyway.

[Greg Battle]

We are in agreement that Google's recent maneuvers have been brilliant. Trust however, if there were 8000 search engines, the boundaries of "fair use" would be pushed even further (as evidenced by the P2P phenomenon) as would the resistance to change. The legal "grey areas" of an industry are directly proportional to number of competitors. Given this, there is no standarization in the hedge fund world; 8000+ hedge funds have 8000+ offeratory memorandums detailing a different business model with "devils" in the details. We cannot legislate the due diligence process - caveat investor. As for enforcement, laws governing breach of fiduciary duties and fraud already exist. Given the number of funds, strategies, geographies, self-interests and investor interests, I believe it makes the level of proactive self-regulation you are suggesting impossible. In the spirit of WC Field's statement, "you can't cheat an honest man," so to will the the competitive dynamics of the hedge fund industry determine how "low" investors choose to go for returns.

[Roger]

Greg, thanks for the comment but you missed the point of the analogy. The point I was trying to make is that the HF industry, like Google, is facing an immense amount of scrutiny. In the HF industry's case it is related to valuation, disclosure, transparency, performance measurement etc., while in Google's case it is the unauthorized use of proprietary content and click fraud, among other things. By displaying a willingness to pay for high-value content and acknowledging its value, it has diffused pressure from a vocal and well-organized group of critics. At the same time it didn't fully capitulate by reiterating its right to organize web content under the "fair use" doctrine. This was enlightened self-interest from Google's perspective and a brilliant move from my perspective. Given the HF industry's issues with transparency, side pockets, side letters, etc., I am suggesting that it proactively deal with these issue, a la Google, before someone deals with it for them (read: SEC, Congress). I am not suggesting the structure of the search and HF businesses are in any way related - only that the HF industry can learn from Google's handling of its critics in a way that preserves its business model while burnishing its reputation.

[Greg Battle]

By comparing an entire industry (HFs) to the actions of one company (Google), you create a flawed argument. You should be comparing industry to industry, which is nearly impossible given how drastically different the competitive dynamics are between the two. The hedge fund industry is not a triopoly like the internet search industry. What you've explained is how the dominant player (Google) controls the introduction of transparency in a manner aligned with more market share (strategic growth through new alliances), cheaper R&D (outsourced IP), and pricing power (low cost producer). Even with all these new bells and whistles, search (or any online distribution mechanism) is a commodity business. 8000+ hedge funds with no dominant players reveals a few things - the fee structures are all over the map, investment mandates are vast, transparency is nonexistent. The HF business is not a commodity business. Plain and simple, for HFs to have any analog to the search industry, the hedge fund industry would need massive consolidation into publicly traded hedge fund companies (don't hold your breath). Until then, you are going to see more 5&50 funds, more elaborate sidepockets, and more creative obfuscation of alpha generation. Just my opinion.

[Christian Cadeo]

Great analysis and really good points.

[Barry Ritholtz]

Nice post -- very interesting . . .