Search: The Rise of Specialization

Adam Smith once said that specialization is a function of market size.

It is no surprise then that the search market, as it grows, is seeing the emergence of specialized, vertically-oriented search algorithms and companies. Searching for good answers wrt the types of search companies starting today and how an investor might want to participate in Adam Smith's prophesy of specialization, I attended today's Under the Radar conference in Mountain View. Under the Radar is a showcase for emerging search and mobile application companies and is targeted at the press and venture investors.

The common abstraction across all the presenting search companies is that while generalized, web-searching is useful, certain classes of queries demand a move from page-link analysis to algorithms more germane to the query at hand. Categories of specialized search include

• Mobile search (optimized for handset form-factors, location-based services, and carriers): Medio Systems
  
• Product search (optimized for product reviews and comparison shopping): Fatlens and Become
  
• Rich media search (optimized for video and audio): Blinkx, GoFish, and Meevee
  
• Travel: Kayak
  

Wrt product search, an example helps to make the point. If you search on Google for "Red Sox," the first listing is, appropriately, redsox.com. If you search on FatLens for Red Sox, you get a listing of available tickets to buy for Redsox games. Fatlens is an example of a company optimized to solve a problem ( help find tickets to events), rather than generic information about a category/topic (help me find the Red Sox home page).

The elephant in the room is obviously, what about GOOG, YHOO, and MSN? The major giants are investing heavily in search and extensions to web search. Will consumers seek results optimized for specific queries - travel, rich media, product shopping, event tickets, etc? Will the very models of analysis that make GOOG so powerful on the web (link analysis) leave room for specialists to enter with algorithms with limited general value but strong, vertically specific search results? Will the search start-ups be destination sites or will they syndicate their specialized search results to aggregators of queries (today's big three)?

A further observation is that the business models of various search companies are coalescing around a few key variables:

• Advertising (Ex. Google Adsense as a partner, direct sales to advertisers)
• Lead generation or referrals (revenue per click, revenue per customer acquisition, etc)

How does a search site generate revenue? A breakdown of revenue per search helps to understand.

At a high level, Revenue Per Search = Coverage x Click-through rate x Price Per Click

• Coverage (#searches that show ads/total # searches)
  
• Click-through rate (total # clicks on ads/# searches that show ads)
  
• Price per Click (total amount received from advertisers/total # of clicks)
• or total amount received from advertisers/total # searches

The specialized search vendors' business models presume that specialization will lead to higher value to consumers (greater relevancy) and hence more qualified leads to advertisers. Sounds reasonable.

WRT verticalization, a few thoughts:
1. Future revenue f(revenue per search or "RPS")

2. RPS f(domain specific problem resolution)

3. Domain specific problem resolution f(verticalization and specialization)

4. Verticalization f(investment in domain specific search algorithms)

5. However, venture returns are a f(scale and market size)

6. Focus limits scale

7. Therefore, future scale must be f(indirect sales and extensible product platform)

Accordingly, I buy that all queries are not created equal. A search for Red sox tickets, Red Sox jerseys, Red Sox highlight clips, and Red Sox pitchers may all require search engines optimized for the nature of each request. I do not buy, however, that consumers will want to visit N number of search companies to answer N number of queries. Nor do I believe that it is capital efficient to raise money to compete to become a destination site.

Rather, I believe the vertical search space will only see scale and success to the extent that major content or web properties see sufficient value in specialized search that they syndicate results from specialist search engines and play the role of aggregator of traffic and integrator of best of breed search function.

The key bet for a vertical search vendor today, in my mind, is that will engineering driven cultures, like GOOG and MSFT, overcome their not-invented-here bias and grant that specialized vendors produce better results than they are capable of producing through incremental hiring of specialists and tweaks to their search engines. If the answer is no, then I think the specialists lose. If the answer is yes, then MSFT and GOOG may morph from technology innovation companies (the best search innovators) to integrators of best of breed function and ad networks that drive queries across underlying and optimally suited third-party search engines. As a user/consumer, I clearly believe we will "win" if GOOG, MSFT, and YHOO aggregate specliazed search on our behalf rather than force us to alt-tab across N search engines to get us our much needed N answers!

GOOG's market cap and traction is clearly heralding in a new golden era of search innovation - will it pay off for venture investors?

Thoughts?