It should go without saying that the current financial crisis is going to loom large over the business plans of young and new software companies.  In fact, there is an article out that suggests that the removal of Lehman and Merrill from the buyer pool has reduced the IT budget of the financial services sector by 6%.  Let’s let that marinate for a moment.

It’s one thing to have a cyclical contraction in spending.  It’s another thing entirely to compound that problem with demand destruction.  Worse still, the demand destruction is not due to a symptomatic pricing issue, but rather the abject removal of key buyers from the market.

Even more complicating is the difficulties in financing businesses operations.  I’m not talking about raising venture money, but good old commercial credit.  Many companies use debt for expansion, and many times that expansion includes computer systems.  Companies are now having their hands forced to not just pay lip service to lowering their CapEx associated with IT, and moving it to OpEx.  They have no CapEx dollars left.  They need (must) find a way to fund software and services.  Enter SaaS business models, and the Cloud more broadly.  I would expect a knee jerk and rapid migration of buyers in the market to seek out SaaS solutions for line of business applications, and a reduction in spending on CapEx associated with IT.

Here’s the sad irony of the current financial debacle.  IT is what got us here.  IT has been wielded as an offensive asset for many of these firms.  The calculations required to price and model out many of the derivative products they were buying in insane.  I almost took a job at Merrill working on their Fixed Income Derivatives desk back in 1995.  Scary.  Here’s what’s more scary: my Fixed Income homework from my FNC235 class (*there’s a nod to all Wharton peeps who ever had Prof. Basak) is what got me the job.  The MD actually said “hire this guy.  I can’t make heads or tails of his homework and he got them all right.”

People worry about Google being the current incarnation of Skynet, but I would look more to the systems which have been handed the ability to make trades for humans based on human created models which very few people understand, much less can maintain in such manner as to adapt to what are being called 10 sigma events.

I was in NYC when 9/11 happened.  I remember a quote that still hangs with me: that we suffered a failure of imagination in our ability to stop the terrorist attacks.  There’s a similar sentiment to be had here.  The failure of imagination in the building of these models has led to many models essentially acting (reacting?) the same way, causing herd like behavior in a flight to or from assets.  The combination of programmed trading, naked shorts and no uptick rule has led to some serious unintended consequences.

From the Buffett special on CNBC tonight, in reference to whether or not hedge funds can justify their fees:

But in Wall Street you have this progression from the innovators to the imitators to the swarming incompetents. And what happens is that the results achieved by the innovators enable the product to be sold by a lot of people simply because the record of a few people was good. So the idea that billions–well, trillions of dollars can be managed to get above average results while charging fees that are way higher than normal just defies the–just defies the logic. So, in aggregate, people are going to be disappointed with the results you get from hedge funds.”

Innovators –> Imitators –> Swarming Incompetents.  I love that.  The same could be said about the Web2.0 trend, but I’m not here to talk about that.  Not now anyway.

I’ve been spending time time thinking about all the flap regarding the surprising decline in Google paid clicks.  (full disclosure – I am long GOOG in the mid 300s)  What struck me about the discussion around GOOG has been how the sagging economy is going to impact the company and it’s fortunes in a meaningful and negative way.  We’re off close to 250 points (35%) in a matter of weeks.

In order for this kind of analysis to make any sense, I would first want to understand how, in a broad sense, the categories of words that are the highest earners, in an absolute dollar sense, are impacted by this coming recession.  The discussion of whether or not we are in a recession (we are not) and whether or not we are headed into one (could be a self fulfilling prophecy) will be left for another time.  For now, what I want to talk about are mortgages.

Yes, mortgages.  I started by playing around with a simple idea – what is going on with the cost of the “mortgage” keyword, and what is going on with the traffic?  I haven’t figured out how to find the trend line for the cost of a keyword, but I can tell you that the average CPC for positions 1-3 is $5.73 – $8.60, for a max of 28,625 projected clicks.  You can get positions 4-6 for considerably cheaper: $0.55 – $0.83 worth a max of 1,894 projected clicks.  To be clear, that’s a difference of daily ad spend of $244,890 and $1,580.  I wish I knew what it cost to get in positions 1-3 in late December.

Now, things get a little bit more interesting when you use the Google Trends tool, which allows you to see how search terms have performed over a given period of time.  I started with the “mortgage” keyword because I knew it to be one of the more expensive, and one of the more clicked on from a paid ad perspective.  Take a look at that chart on the right.  Looks like searches have actually gone up over the last few months.  Now, one could argue that these are all desperate people looking to get out of a bad loan.  Possible.  One could further argue that there is no one willing to lend to these people.  Also possible.  Regardless of that truth, someone still paying for those clicks.  

If you look at the chart at the left, you can see that the cities that have well documented troubles with subprime are well represented here.  So the question remains, is GOOG’s business in trouble, or will there be some subset of words that actually drive more income for the company?  We all know that when financial troubles set in, people go looking for the get rich quick schemes and other magic pills.  Think of all the Ebay Power Seller guides that will get sold to people following the Dave Ramsey model of getting out of debt (note: I listen to Dave every day, and his advice is pretty solid, but he does like people to sell their stuff).

I wish I had access to a little more data to further explore this concept.  I throw this post out there in the hopes that someone smarter than myself, or with access to more information, takes a deeper look at this idea.  Bottom line, I am actually holding out on buying more GOOG because I don’t think we have bottomed.  If it touches 400, I am in, and backing up the truck.