How does the business model of the Google search engine differ from those of DAX-listed companies such as Siemens, BASF or adidas? The answer from the point of view of a business economist is quite simple and is: through the cost structure. While Siemens & Co. have to spend a not inconsiderable portion of their sales on financing their manufacturing costs, Google's service provision costs almost nothing.
Cost structures: Digital vs. Classic
We compare Google's business model with that of a traditional industrial company - specifically an automotive manufacturer such as VW - using a simple numerical example.
In order to ensure comparability of the two different models, we focus on the relationship between variable production costs (see below for explanation), which are incurred in the creation of services or products, and sales. Overhead and fixed costs are not included in the analysis in either case.
Cost structure of a search engine
The only variable costs incurred by the search engine in providing the service are the energy costs for processing the search query. Transmission costs are not incurred by the provider, as these are borne by the customer.
- The estimated energy consumption for processing a search query is 0.0003 kilowatt hours.
- Converted to the current German price of a kilowatt hour of about EUR 0.13 (as of November 2018), the estimated cost of a single search query is EUR 0.000039.
Wir stellen nun die Energiekosten dem potenziellen Umsatz pro Suchanfrage gegenüber. Dazu müssen wir die Frage beantworten, wie viel Prozent der Klicks auf Google letztlich auf den bezahlten Anzeigen (Google AdWords) landen.
- We assume that about 1.68% of Google search queries result in a click on a Google AdWords ad.
- The click on a Google ad usually brings the company between 0.4 and 2.00 EUR (average value: 1.2 EUR).
- Google therefore converts an average of 0.02016 EUR per search query - i.e. about 2 cents.
That doesn't sound like much at first. Nevertheless, the turnover of a search query exceeds the costs by more than a factor of 500 (specifically: 516,923!).
Cost structure in automotive production
To enable a fair comparison between the business models, in a second step we determine the relationship between variable costs and sales in car production. Variable costs of car production include the consumption of goods and the energy costs for processing the materials.
- Based on current estimates, the cost of materials in the automotive industry is around 50% of the selling price.
- The exact figures are a closely guarded trade secret. In addition, the ratio between sales and cost of materials is generally higher in the luxury and premium classes than in the compact class.
Regardless of whether you are at the top end or the bottom end of the scale - the ratio of sales to variable costs hovers around the number 2. The factor is thus about 250 worse than at Google. And it doesn't matter whether we're talking about a new Bugatti model or a Skoda model that has been in production for years.
Falling marginal costs through digitization
Digital cost structures therefore have a decisive advantage over industrial cost structures. This applies not only to the Google vs. VW comparison, but to all companies that implement their business models on a digital basis. This creates a worrying gap between the business models of numerous large German companies and the potential business models that will shape the way people live and work in the future.
The reason for the change lies in the reduction of marginal costs of production triggered by software-driven production and sales processes. To understand this connection, the concept of marginal costs must first be examined in more detail.
What are marginal costs?
The cost structure of a company consists of fixed costs and variable costs.
Fixed costs are the unchanging cost components of production that are incurred month after month. These include, for example, wages and rents.
In addition, there are cost items of production that only occur when a product is actually created. The individual parts (e.g. the steering wheel) of a new VW are variable costs. These are assigned to the creation of the individual product.
Marginal costs (GK) are the costs that arise when one unit of a product is produced more. They are thus the first derivative of the cost function, i.e. the addition of fixed costs and variable costs. At first glance, this sounds complicated, but it is not.