The Webmail Wars

Gmail is all cool and slick, but there is no reason why Gmail's competition can't match its functionality. Since the release of Gmail's beta in April, Yahoo has bought two email companies to bolster Yahoo Mail, and both Microsoft and Yahoo have increased the storage quota of Hotmail and Yahoo Mail, respectively.

Microsoft and Yahoo are certainly going after the functionality of Gmail, but they are likely intending to match more than just the interface and storage quotas. It makes perfect sense for them to align the underlying business models of their webmail services with that of Gmail. Currently, Microsoft and Yahoo's webmail services are earning revenue by selling premium email accounts, and ads. Gmail on the other hand is using an automated email scanning system to push highly targeted ads. Gmail's system is a form of paid search, and under this system users see ads relevant to the contents of the email they are viewing. Obviously, Google's calculations show ads selected via email scanning to be a much better revenue generator, or the company couldn't have justified Gmail development, 1 GB quotas, and the fight it is picking with Microsoft and Yahoo.

Microsoft and Yahoo will need to copy Gmail's business model simply to stay competitive. If they hesitate, Google will continue to steal market share by offering large storage quotas which it can afford courtesy of Gmail's superior business model.

Actually, Gmail's business model suits Hotmail and Yahoo Mail even more than it suits Gmail. Hotmail and Yahoo Mail are established players in the webmail market, and these services don't need to make any effort to capture market share. According to MSN International, Hotmail has 170 million accounts, and an average user views 100 pages on Hotmail each month. This is a huge untapped market for paid search. Moreover, Yahoo and Microsoft can use such ads to shore-up some of their other businesses. For instance, Yahoo could use such ads to lift its sagging Yahoo Auctions unit. Clearly, this new business model has the potential to transform previously stale money losing webmail services into highly valuable assets.

All of this suggests that in the coming months, Microsoft and Yahoo will roll-out much improved webmail user-interfaces, and complement their webmail services with automated email scanning systems for the purpose of ad placement. Such systems will lead to some controversy, as some people are worried about the privacy implications of automated email scanning. Fortunately, Google supporters have made a lot of effort to appease Gmail privacy concerns, and the road is mostly clear for Microsoft and Yahoo.

After finishing the software upgrades, Hotmail and Yahoo Mail will likely go on an offensive to capture market share. Interestingly, it is possible for all the major webmail players to gain market share simultaneously; increases in market share can come at the expense of smaller webmail players.

The increasing sophistication of webmail means that small webmail players can no longer compete. Even though a good web-based user-interface is a one time expense, but still small players can't afford it. Also, big storage quotas require losing money at least initially, and small players typically don't have deep pockets to take that route.

According to Forbes Magazine, Hotmail is the biggest webmail provider with 33 percent of the market, Yahoo's share is 30 percent, and Gmail is 3rd with 4 percent of the market. This means 33 percent of the market belongs to companies without the muscle to defend their turf, and this portion of the webmail market is potentially up for grabs.

Gmail's small market share means Google can more aggressively go for market share gains. If Google decides to take a loss on every Gmail account in order to gain market share, it will be taking a loss on tens of millions of accounts. But, if Microsoft and Yahoo decide to do the same, they will be taking a loss on hundreds of millions of accounts.

The same line of reasoning suggests that Google will be tempted to create a simple and attractive interface for storing files in Gmail accounts. The move will create a competitive advantage for Google, and will simultaneously hurt its primary competitors.

A 1 GB storage quota doesn't force a webmail provider to reserve 1 GB of storage for each active webmail account. Most users don't fully utilize their storage quotas, so if the average user is only using ten percent of their quota, the webmail provider can get away with 100 MB storage per account plus a safety cushion. If Google decides to make it easy to store large files in email accounts, users will tend to use more of their quotas. Of course, the move will force Google to maintain more storage, but it will hurt Microsoft and Yahoo ten times worse. Microsoft and Yahoo will be forced to follow Google's lead, and the two companies will need to invest an order of magnitude more than Google to match Gmail's functionality.

Ironically, Google's moves so far seem to have primarily benefited its competition. Google could have done much better if it had tried to surprise Microsoft and Yahoo by aiming for 50-100 million users in 6 months, instead of going for a limited Gmail beta. Sure, Gmail would have inevitably experienced some security problems, and technical glitches, but for every Gmail problem its competition would have experienced five such problems in an attempt to rush upgrades.

Google's relaxed attitude might be due to some patents the company has filed with the US patent office. The patents pertain to serving targeted ads based on content. However, with the stakes so big, the patents are certainly going to get challenged, and it isn't clear if the patents will hold up in court. Also, if Microsoft and Yahoo are able to confine Gmail's gains, they might be able to license the patents from Google in exchange for ceding marketshare.

Google's lazy attitude has certainly given Microsoft and Yahoo time to hit back at Gmail. Yahoo's acquisition of Oddpost, and its subsequent integration with Yahoo Mail will likely create a richer webmail experience than Gmail. Microsoft is probably not far behind either on the interface front. The two companies can even attempt to beat Gmail's 1 GB quota.

Microsoft is especially well-positioned to make big moves to counter Gmail, because of its healthy balance sheet. The company can afford to lose money for years in order to strengthen its market position. Also, the expense to gain market share is mostly a one time thing. Users don't switch their primary email accounts often, as it is a terrible inconvenience, and once the 33 percent small player owned webmail market gets divided up, the webmail wars will be over.

The winners of the webmail wars will certainly get to enjoy a rapidly expanding paid search market, but the repercussions will likely extend further. The paid search model will get applied to other web services, and web interfaces will become more advanced and richer.

by Usman Latif  [Nov 10, 2004]

Updated November 13, 2004.


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