Tuesday, May 03, 2005

Gmail: A Strategic Triumph or an Impending Disaster

It has been over a year since news came out from the enigmatic search-engine darling, Google, that it is entering the already saturated e-mail market segment. On 1st April, Google announced its email service, Gmail, and claimed to redefine the whole email experience with its 1GB storage space and a highly innovative user-interface. Initially people thought it was a bad April-fool joke (same as Google Gulp, which it spread a year later), however, Google was going public soon and it meant business. So far, Gmail has managed to deliver what it asserted and has forced other email giants such as Yahoo and Hotmail to overhaul their whole business model. However, the question is why Google decided to enter this free-service market and whether Gmail’s business-model is sustainable.

When Google started in 1996, its founders Larry and Sergey, had no clue how they would make money out of it. There is no evidence to suggest that even its famed VCs – Sequoia Capital and Kleiner, Perkins, when they fuelled it with tons of money in 1999, had slightest of the idea how they would make money out of this search engine. Only in 2002, Google picked the cost-per-click keyword based advertising idea and went through a major overhaul in its business strategy. Internet advertising was in dumps since internet bubble crashed and used to make for a bad lunch joke in early 2000s. Some search-engines, such as Overture (later acquired by Yahoo), were already doing some intelligent keyword based advertising with reasonable success. However, Google was the first to show how serious money could be made out of ad placements. Today, its multi-billion dollar empire is all built around this simple keyword based ad concept.

Implementing keyword based advertising for a search-engine is not any sort of a technical breakthrough. 10 software engineers high on their latest Desktop doohickey can implement the whole interface in less than a quarter. What’s important is the number of eyeballs (another calumniated internet bubble term) you have to show the ads and Google’s search engine had more of them than anybody else. Google was the first major search-engine to adopt this business-model and took full use of its first-mover advantage.

Although Google’s search engine is considered the best, the technical lead it enjoys is not sustainable. Both Microsoft and Yahoo have enough resources to funnel into their R&D facility to catch-up with Google and are already heading in that direction. Switching cost for people for moving from one search engine to another is essentially zero. There is definitely some brand royalty but that alone is not sufficient. So, Google’s empire build around ads and eyeballs can crumble down the day Microsoft and Yahoo gain technical advantage.

So what switching barriers Google can create to retain these eyeballs? Email service is one obvious answer. On internet, people change their favorite websites for news, shopping, games etc all the time, but not Email service, which has big switching barrier in the form of the hassle to redistribute email address to all your acquaintances. So, if you can glue people to your Email service and keep showing them ads alongside their emails, you’ve hit on a sustained business model

In view of already established email services like Yahoo, Hotmail, AOL etc, Google had to offer something really stunning to make people switch to its email service. Mail-box size was the magic word. In comparison to the constricting 20-30 MB email space offered by other services, Google’s announcement of 1000 MB mailbox size was music to the ears and was more than enough to overcome most of the switching barriers.

Besides, it’s well-known about the habits of internet users that first site they visit on internet is their Email service. And it’s also a known fact that the first website you visit significantly influences which website you go next. On both fronts, having an Email service is a major strategic advantage in terms of capturing eyeballs.

Moreover, Gmail service adds back to the brand of Google and helps instill a royalty for the Google’s search engine. Google puts its search engine functionality prominently right on top of Gmail’s interface to make sure its flagship service always stays visible.

Recently Google announced that it is going to double Gmail’s capacity 2 GB. It’s not a secret anymore that majority of the people doesn’t need that much space. As one Yahoo spokesman puts it ‘beyond 1 GB mail-box size is just a number’. And this is becoming more evident by the fact that now Google has decided to go for ever expanding mail-box size. A certain amount of size is added to users’ mail-box everyday. Ever-falling prices of hard-disks might also be a reason behind this move.

So, question is what Yahoo mail and Hotmail did wrong? Did they underestimated the value of cost-per-click advertising and opted for wrong business model? Instead of making money through ads, where the revenues come through ad-sponsors, they opted for making money through end-users by giving them option to upgrade to a bigger mail-box size.

This is analogues to advertising business on TV. Some TV channels come for free and channels make money by showing ads. Other channels such as HBO, broadcast ad free contents and make money by charging end-users. Both business-models work fine on TV. However, rules of the game are different in the case of internet advertising. People are not bothered by ads on their webpage as they are bothered by ads on TV. So, they don’t see any value for paying for an ad-free email service. Hence, the business model of Yahoo mail and Hotmail appears flawed.

However, the question is why other email services haven’t followed the suit and haven’t gone for a full-fledged Gigabyte email service like Google. There could be two reasons. First is that they don’t have enough eye-balls traffic and ad sponsors to sustain such massive infrastructure. However, same can’t be said in the case of Yahoo mail and Hotmail. Second potential reason is that they don’t think enough money can be made through ad-clicks to justify giving 2 GB of space to every user. Let’s try to perform a back-of-the-envelope calculation to test Gmail model’s profitability.

Both Yahoo and Hotmail still sell their Gmail equivalent ad-free email service for $20 a year. In view of Gmail’s threat, it’s safe to assume that they are pricing their service at bare minimum. So, Gmail needs to make approximately the same money through its users every year to stay profitable. Google on average charges approximately 10 cents from its advertisers (based on the prior advertising experience of authors) for each click through. That means a Gmail user has to click on

$20/0.10 = 200 ads every year ~ 1 ad every two days for Google to make profit.

Commonsensically, it appears extremely high as most people don’t click on ads appearing in Gmail window that often (I haven’t clicked on a single ad since I’ve started using Gmail a year ago – but my case is likely to be extreme).

So, at least above calculation doesn’t verify the sustainability of the model. Then why Google decided to jump into Email business? Was it just a hasty dot-com style move? Google can’t afford to shut-down Gmail or reduce the offered space later – collective odium of millions of users worldwide would blow the whole Google Empire away. Maintaining such expensive service can suck the life and blood out of Google and Gmail might turn out to be 800 pound guerrilla which can bring the whole Google down with it.

One possible justification for Gmail might be that Google has found some way (which Yahoo and Hotmail haven’t) to keep the variable cost for adding each user very low and to significantly reduce the fixed cost incurred in establishing the infrastructure by distributing it across more and more users. Another possible explanation is that Yahoo and Hotmail still haven’t learned their lessons and pricing their paid email service way too high. Besides Google, only time knows the answer.

(Those of you, who haven’t got the chance to experience the magic of Gmail yet, please drop an email at zensaab@gmail.com to receive an invite – enjoy it till it lasts :)

Sach Jain & Karine Street


Blogger Jay See said...

...google has announced this personalization tool now. Probably part of the same 'create switching barrier' strategy. What next...free web hosting?

11:28 AM  

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