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

By Jeffrey F. Rayport

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."