Peter Thiel claimed at Farsight 2011 yesterday that running a search engine currently incurs about $5-10 billion in fixed costs, meaning that search is a natural monopoly where players can’t make money unless they have about 30-35% market share (video here starting around 8:00). It’s a fascinating analysis of the search industry, although in my mind hopelessly misguided.
First of all, Blekko is a clear counter-example. It’s a viable search option and has a much lower burn rate. DuckDuckGo is also an interesting product, although it doesn’t quite qualify as a contradiction of Thiel’s thesis since it runs partially on APIs like Yahoo’s.
Ignore the Existing Cost Base
More generally, taking the existing cost base as a given in technology markets is pretty foolish, from a couple of perspectives. Consider the 80/20 rule. In most areas, Google and Bing have already exceeded user needs and are working on features that provide very incremental benefits. It might be nice getting to a result a couple of seconds faster with Google Instant, and Google’s spelling correction (which occupies an entire development team) is pretty cool. However, a new competitor can get to 80% of Google’s spelling correction pretty quickly. No one’s going to miss the remaining 20% if that product provides some truly novel benefit. Whether DuckDuckGo’s privacy or Blekko’s slashes qualify as something many people want remains to be seen. But Thiel is ignoring the entire concept of disruptive versus sustaining innovation.
Would Thiel make the same argument in the car industry? If we looked at Toyota and General Motors, would we assume that starting a car company requires billions in fixed costs? Clearly not; just look at Tesla.
Fixed Costs Aren’t Really Fixed
We all know that fixed technology go down over time, from hardware to bandwidth to (open source) software. New upstarts in search will be able to do more with less, especially if they choose to focus on providing value along a specific dimension of customer needs rather than trying to do everything at once. Think about what that $5-10 billion in fixed costs really represents: video search, image search, ad serving, real-time search, and a million other things. Do you really think every search engine needs to offer all of those features? Clearly not!
The search field is disintegrating into more specialized applications. Although it’s in Google and Bing’s interest to keep all of those applications under the hood of one monolithic search engine, that’s clearly not the only model. I will bet you that Hipmunk is going to beat the pants off Google and Bing for flight search (at least until they get bought), and with much less investment. There’s incredible value in not being tied to an established mindset and infrastructure. That’s the whole point of startups.
What’s Really Disruptive?
The key for search startups in avoiding the fixed cost trap is that their innovations must be truly disruptive. They have to satisfy a need that current search engines do not, that users care about, and that is not too tightly coupled to the entire search infrastructure that incumbents have in place. I think this the main problem for Powerset, the semantic search startup Thiel invested in. They were targeting the mass market, and thus their strategy was tightly coupled to all the features that mass market users have come to expect. In addition, generalist users probably didn’t care enough about semantic search to give up other features. If customers aren’t willing to give up other benefits for your innovation, then it’s not really disruptive. Powerset might have done better if they had focused on a niche that absolutely had to have semantic features (maybe patent search?) and then expanded over time into other segments.
Since I’m working on a vertical search engine, I’m hopelessly biased. And I actually think Thiel’s plans to invest in underlying infrastructure technology make a lot of sense. I just wish he hadn’t described the economics of search in such a superficial way.