Technology

Can Anything Derail Google's Growth Engine?


The online ad market is slowing, and Chinese rival Baidu is a global search threat. But Google's idea lab is still a powerhouse to bet on

You probably won't get rich betting against Google (GOOG). Every quarter, cynics predict a stumble. Most of the time, they're wrong. Even when Google misses analysts' forecasts, the company still manages to deliver impressive gains.

Still, as Google heads toward $20 billion in sales this year, ranking No. 5 among the fastest-growing tech companies tracked by BusinessWeek, it's tempting again to ask whether anything can derail the company's growth engine. And while the company's reach and potential are undeniable, it will undoubtedly face challenges on many fronts—particularly from rivals, regulators, and the recession.

But first, there's the question of the company's reach. Google has an infinitely scalable search advertising model—fueling geometric growth selling ads on its own site through its AdWords program, and on more than a million third-party sites through what it calls AdSense.

Therein lies the first challenge: The company is too successful. Google's share of U.S. search queries is 63%, and it logged its fastest year-over-year query growth in the third quarter. If Google continues to place search ads on AOL, with 4% share, and partners with Yahoo! (YHOO), which has 20%, Google would see its effective search share (direct and indirect) rise to 87%. Even without the added reach, Google gets more money from search queries than its competitors. As a result, analysts estimate the company captures 75% of search-ad revenues and over 90% of search-ad profits. That's a powerful market position.

third-party dependency

So what's the problem? Much of the company's growth will happen in the lower-margin AdSense business. As Google becomes the market for search, by definition it grows with the market, rather than ahead of it. That means it must rely on AdSense over AdWords to drive growth through third-party sites—especially as it infiltrates new markets, such as TV, radio, print, and even electronic games.

But not all its search businesses are created equal. A dollar sold on AdWords translates into 60¢ to 70¢ of operating profit, which has turbocharged Google's financials. (AdWords is two-thirds of Google's business.) By contrast, a dollar sold through AdSense translates into 40¢ of net revenue to Google and only 10¢ to 20¢ of operating profit.

Now, consider Google's global rivals. Asia is the world's fastest-growing region for Internet search—and China is the engine of online growth in Asia. With 253 million Internet users, China has surpassed the U.S. Google may be No. 1 in Australia, Singapore, and India, but it's a distant No. 2 in China. Its archrival, Baidu (BIDU), has a 63% share, compared with Google's 26%. Either Google reverses positions with Baidu, or its pace of global search growth slows.

Google has pursued growth through diversification. While even CEO Eric Schmidt admits "Google is focused on too many things," there's no arguing with the imperative for innovation. Salesforce.com (CRM) CEO Marc Benioff says Google ought to take a page from archrival Microsoft (MSFT). "What they need to do is build a full portfolio of revenue, as Microsoft has," he says. "They have a fantastic cash cow. They need a goat and a chicken."

mixed acquisition record

Happily, there's a lot of promising stuff going on. Google Apps is the first in a series of offerings placing Google at the forefront, with Amazon (AMZN) and a few other tech giants, to make cloud computing a reality for large and small enterprises alike. Google Android seeks to revolutionize the mobile phone with its open operating system for content and applications—and it could reach beyond the phone to other Internet-enabled devices. Mobile search is already led by Google, with a commanding 63% share. (It's a duopoly: Yahoo owns another 35%.) But none of these initiatives, as yet, is generating meaningful revenue or profit. So much for the goat and chicken.

Google's record on growth through acquisition is equally mixed. Google bought 5% of AOL, predicated on a $20 billion valuation, but Wall Street thinks the investment is already impaired. Google acquired YouTube, but it has yet to crack the code on making money from online video. Later, Google acquired DoubleClick, the online display advertising company, to some acclaim. The company was widely viewed as a cash machine—except in a recession, when display sales are down. Still, Google has a war chest of some $17 billion in cash and cash equivalents; now isn't a bad time for it to go shopping—online assets are all deeply discounted.

Which brings us to the macroeconomy. Growth in the online ad market has slowed by half. Search is the most defensible type of online advertising, but it faces downward pressure. Users are clicking more, but they're buying less. So advertisers are lowering prices paid for keywords. As Google has positioned itself increasingly as an ad-driven enterprise, it's subject to the tribulations of the media sector. And it's not as if the technology sector is feeling a lot better these days.

a cabinet post for schmidt?

Add an upcoming Presidential election, and you've got real uncertainty. Schmidt is actively campaigning for Barack Obama. If John McCain wins, Google could face retribution. If Obama wins, Google could see increased antitrust resistance to its proposed search tie-up with Yahoo and a tightening of consumer privacy regulations from a Democratic Congress. That, in turn, could hobble the efficacy of online advertising. There's also an outside chance Google could lose its CEO; Obama's campaign has talked about making Schmidt the country's first chief technology officer.

So how does Google extend its winning streak? In the end, it's arguably all about amassing the most talent without falling prey to what's known as Big Company disease, a condition that can leave a once-fleet-footed business complacent, overstaffed, and bureaucratic. In a recession, Google will need to do what "normal" companies do: streamline its workforce, cut budgets, and realign investments.

But it's also got to keep generating brilliant ideas. Google operates a vast network of data centers housing over a million computers operating as a massively parallel computing resource. It may be the most powerful "computer" in the world. Marry that with the hundreds of millions of queries Google "sees" everyday, and you've got a laboratory of unprecedented scale to address critical technology, marketing, and media measurement questions. If that's not a growth engine worth betting on, what is?


Steve Ballmer, Power Forward
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