The economic theory of adverse selection suggests that we should be suspicious when companies go public. Here is a summary of some research on the topic. If your big idea has such a stunning future, why let other people in on the action?
Google.com will be going public, and John Gapper at The Financial Times has his doubts. Are they trying to cash out at their peak? Here is part of his critique:
The more pertinent question is whether its business model will retain the lead. To start with, it can no longer rely on others failing to grasp the importance of search. Algorithmic search engines are tough to design and maintain but others such as Teoma, owned by Ask Jeeves, and Yahoo’s Inktomi are catching up.
So is Microsoft, which is developing an algorithmic search engine that may be launched by spring next year – the likely time of Google’s IPO. By 2006, it will be bundled into the next generation of Windows – Microsoft’s usual tactic when faced with superior technology owned by others.
The biggest uncertainty is whether its focus on internet searches to the exclusion of anything else will remain the best strategy. Although it has clearly been popular so far – Google performs 200m searches a day and is responsible for an estimated 75 per cent of all referrals to websites – it could become an Achilles’ heel. It means that Google has no unique content, and no long-term customer relationship with the individuals who use its technology; it is only as good as its last search. That contrasts with sites that have their own databases and customer networks, such as Yahoo, with its 100m registered users, or Amazon, which holds a mass of data about the products that it sells.
The difficulty for Google will come as rivals combine search with other resources in ways that it will find hard to match. The launch of Amazon’s “Search Inside the Book”, which allows customers to search pages on its database for references and information, is one example of how search technology can be applied to data within internet sites.
Yahoo is augmenting internet search with its own information. Its Yahoo Shopping service not only allows users to search for the cheapest outlet for different models of digital cameras but also combines the results with its own guide to buying cameras, and with user reviews. Google’s own shopping service, known as Froogle, also displays the cheapest prices but looks flat by comparison.
My take: I’m not buying any shares. My understanding of the technical issues is weak. But I understand the theory of adverse selection pretty well.