Google: Where Failure Is Instructive

Google Inc. (GOOG), the internet search behemoth and undisputed king of online advertising, tracking and measurement has recently announced its presence in the world of network television advertising. Google TV Ads have reportedly begun booking upfront deals with key advertising agencies in an effort to establish itself as a major player in this lucrative market.

“Upfront” is a term used in the TV marketing biz to describe the glamorous meetings at which advertisers commit to purchase commercial airtime prior to the start of the television season. Major upfront events, which are held in New York during the third week of May, are typically characterized by elaborate presentations, five star restaurants, celebrity elbow rubbing, resulting in enormous monetary commitments. Google, however, is taking a different approach. The Google TV Ads platform, which has already secured seven-figure commitments from agency clients of Deutsch and Saatchi & Saatchi, employs an auction-based system that allows advertisers to gauge the impact of their ads on audiences during different time slots. This is intended to optimize ad spending. This should sound familiar since the platform employs a similar technology to that of Google’s wildly popular online search advertising system, AdWords.

Google’s apparent early success in the television advertising marketplace comes at an important time for the company. In April, Google reported a decline in quarterly revenues for the first time as a publicly traded company, revealing that the seemingly infallible internet giant is not immune to powerful macroeconomic forces (read recession). While the company still managed to grow its net income by slashing costs and curbing capital expenditures, the breakneck revenue growth that propelled its stock to a high of $747.24 in November ’07 seems to be slowing. As such, analysts and investors have urged Google to diversify its revenue stream, which is almost singularly driven by its online search advertising platform - to the tune of 97% in FY‘08.

Google’s employees have enthusiastically embraced this task, spurring an outpouring of new products and features. Most of these new initiatives have failed to generate any significant revenue or profit for the company, as most are given away free of charge online. Cue the company’s headlong rush into the world of traditional advertising. Google’s management felt that their unique strategy of allowing consumers to tailor a company’s advertising through their feedback and buying behavior would transfer well from the internet to radio, print, and television. Unfortunately, Google underestimated the complexities of these ad venues, human behavior and embedded relationships and, after several failed forays into the former two markets, both Google Radio and Google Print Ads have been discontinued. This is all the more reason why the recent success of Google TV Ads should be music to the ears of any Google shareholder.

But does it really matter whether or not Google TV Ads is a lasting success? Are any one of these new ventures singularly central to the company’s future? No. Investors should realize that in holding the company’s stock, they are partial owners of one of the most innovative and ambitious companies in recent history. Although Google built its reputation on the back of its groundbreaking search engine and realized its financial success through the dominance of online search advertising, neither of these features embody the company’s competitive advantage.

Google’s true competitive advantage lies in the unparalleled talent and creativity of its workforce, and in the company’s limitless capacity to explore new ideas and invest in those ideas that work. The firm has the cash on hand to make the right investment when commercial viability is achieved. The company’s management has liberally interpreted its corporate mission, “to organize the world’s information and make it universally accessible and useful,” freeing Google’s employees to pursue an extensive range of projects related to the organization and transmission of information.

Some of the company’s notable recent successes include its acquisition of YouTube, its partnership with Apple’s (Nasdaq: AAPL) iPhone, the creation of the online Google Docs platform, and the introduction of the Android mobile phone operating system. The Android operating system is a particularly promising venture that could pay off tremendously for Google as it continues to negotiate with wireless carriers around the world. Mobile phones utilizing the Android system are already being promoted in Asia by China Mobile Ltd (CHL), the world’s largest mobile phone operator.

However, as highlighted by its foray into radio and print advertising, Google is far from infallible. In fact, the company’s brief history is strewn with some notable product failures, including the initial Google Video platform, the now defunct virtual world called “Lively,” and a marginal social network dubbed “Orkut.” Should the company be embarrassed by these failures? As a portfolio manager purchasing Google shares on behalf of my investors, I applaud Google’s adventure and grand ability to fail. In fact, as Marissa Mayer, Google’s VP of Search Products and User Experience states, failure is an essential step in the process of learning and innovation. In accordance with the mantra of “failing fast, but failing smart,” the internet giant embraces its missteps as an opportunity to learn about its customers and to reposition itself for future success. In Google’s case, failure is cheap and customer insights are invaluable.

We are long Google, believing that the company surpassed what Microsoft (Nasdaq: MSFT) achieved in its prime (we are long MSFT as a value play) through its willingness to brazenly pursue new, groundbreaking ideas and to continually reposition itself by investing in promising ventures. Google’s unbounded creativity and high absorptive capacity set it apart from its competitors, which now range from software giants and online advertisers to telephone companies and book publishers. Google shares are currently trading near $400, a considerable discount to their $700-plus zenith in ‘07, and have plenty of upside potential. The company’s first quarter earnings report highlights management’s increasing focus on running the business and controlling costs. Revenues from the firm’s online advertising platform will benefit from increased marketing budgets as the global economy stabilizes. We will continue to follow the development of Google TV Ads with interest. In the unlikely event of its failure, we’re not worried. Failure can be instructive and Google is a model student.

Shout out: Colin Sloand is spending the summer working for one of my favorite professors at Lehigh University. He is also researching and drafting for me. This is his first post – great work Colin.

Disclosure: Mr. Corn is Chief Investment Officer – Equities of Beacon Trust Company. Through various equity strategies under his supervision he is long GOOG, AAPL and MSFT.

Comments

[kmanm:]

I will argue that Google's best years are behind it. I personally think TV ads will continue to decline even if the economy recovers due to the popularity of DVRs. Google is still the best search engine in the world but other than that it really doesn't have much of anything else. Yes, they have great products like gmail, google voice, googledoc and etc but they don't ad much to the revenue.

The big question for google is that if companies will be willing to pay top dollars as they did 3-4 years ago for google ads? The way the economy is, I have my doubts.

May 27 08:42 AM

[Leftfield:]

This article has convinced me that Google has lost it. All this stuff about their talent and it's applicability anywhere reminds me that Thomas Edison lost his fortune from patents in the steel business. He wanted to go into a business that still had major cachet having been huge for generations. But it's peak had been reached and he didn't have the expertise in it. Like Google and TV today, I guess.

May 27 10:44 AM

[LA Tech:]

I concur with Kmanm and Leftfield.

Google is the worst marketing company, maybe ever. Google Apps is a waste of time and a huge money loser. YouTube is still bleeding.

It is a good thing Google does paid search very well for it subsidizes every other dumb idea that isn't generating revenue's or profit's.

May 27 11:19 AM

[modelportfo...:]

Other posts are quick to write off Google's competitive advantages and great future. Your article summarizes many of these advantages: cash, employee talent, etc.

I believe that the world is moving its information needs to instant gratification with real time, server based (read: cloud) computing. YouTube and Android are products (video and software) that fit their vision of the future. Search is the starting point for Google's strategy of organizing the world's information and its experimentation in many other areas mirrors what consumers are doing. Google has a unique ability to create an algorithm or database to describe and accurately predict what we do and would be likely to do and therefore stands at the intersection to collect tolls through their advertizing model. Apps and mobile cause us to be sticky users of Google search. But clearly not everything can be mathematically modeled---areas recently abondoned by Google. I suggest that investors who take a 12-24 month view will be amply rewarded.

May 27 12:49 PM

[tuj:]

"Thomas Edison lost his fortune from patents in the steel business. He wanted to go into a business that still had major cachet having been huge for generations. But it's peak had been reached and he didn't have the expertise in it"

Edison tried something like 400 variations of materials until he found a suitable filament for the light bulb instead of just hiring a materials engineer. He also passed on Tesla and on AC power and fought a vicious war trying to promote his DC system to which he had strong financial ties, but which had distinct draw-backs, hence the network of AC lines that bring you your power today.

Everyone said 'Why is google trying to make a webmail app? That's dumb, there's already 1000 of those." And yet Gmail pretty much smacks down everything else. Google docs is getting there. iGoogle is strong. Google maps and google earth; unreal products, especially when you see what people combine it with; that's the real power. They have left their platform open for others to expand upon, unlike their competitors like Apple and M$.

Microsoft once had the same kind of talent: Access was written by one guy in his spare time. Now it takes 5000 developers to crank out the crap that is Vista.

May 27 01:47 PM

[Hot Richard:]

I'd love to live in a country run by Google. Provided I could leave freely for other countries run by WalMart, Microsoft, and Amazon if they started cramping my style.

Tuj,
To be fair, the original code for Access could've been written by any one of 1,000 college students in less than a semester.

May 27 02:35 PM

[LilBob:]

I'm not as complimentary of the whole "cloud computing," concept. For one thing, it requires constant attachment to some means of technological umbilical cord, for another it ignores the reality that in a climate of global warming, those cords are becoming ever more tenuous. Floods, hurricanes and tornadoes play hell with WiFi connections. Also, that constant state of attachment means that any individual who chooses a life of constant connectivity may be instantly and constantly tracked by whatever authority wishes to do the tracking. In times past no society would ever have submitted to the notion that free people should simply accept the idea of being under constant state surveillance, but with internet technology we seem to have accepted this state of subjectification as an unfortunate consequence of Web 2.0 technologies.

Google will most likely follow the same path as all giant companies, possibly even eventually sharing the same fate as GM and Chrysler. As for employee talent, the internet will eventually come to be regarded as nothing more than a communications medium: one that has some utilitarian potential as well as dangerous drawbacks. Web-utopianism will eventually fall by the wayside as we come to realize that a system that really does nothing more than let human beings communicate has no inherent ability to improve the quality of the human beings doing the communicating.

Human behavior also tends to occur in shifts. We had the baroque era, which was followed by the classical era, etc. The era of Industrial Revolution may be coming to the beginning of its end, and we may start to see greater numbers of people shunning technological advance, reverting to more agrarian lifestyles and adopting less consumptive lifestyles. Time will tell.

On May 27 12:49 PM modelportfolio2003 wrote:

> I believe that the world is moving its information needs to instant
> gratification with real time, server based (read: cloud) computing.

May 27 07:58 PM

[ebor:]

People should remember the other advantage of Google providing so many apps and services (like gmail or Google Earth) that benefit people but don't directly generate revenue: they are building a brand name people trust. Google is a very young company, yet already people have a more positive image of it than Microsoft ever had. That brand name is enough make a lot of people choose an Android over an iPhone as long as the two are in the same league. Also, Google does a very good job integrating their products together. 90% of the google ads I click on are while checking my gmail, and Google Earth pictures soon made their way into google maps to offer satellite views as well as map views (along with ads of course). Although 97% of Google's revenue may be directly from ads, that can't be disentangled from the popular use of its other products or the value of its brand name.

May 27 08:23 PM

[Stephen Fra...:]

1. Google's share price high water mark of $747 happened during a ridiculously euphoric era and is very far out of reach today.

2. I used loved Google Print, and like Adwords, it allowed small advertisers to play in the big kid's sandbox. RIP.

3. ebor: Google might have a better brand image, but all companies, large and small, still use Excel and PowerPoint.

4. Mr. Corn: instead of giving this article's true author a "shoutout," why dont you encourage/let him actually publish under his own name next time?

May 28 12:08 AM

[assman:]

Google sucks! They took and great and incredibly profitable business and destroyed it. How?

1. By diversifying into way too many useless areas.

2. Hiring way too many useless engineers. You can come up with as many brilliant ideas as you want. Brilliant ideas != great business. For brilliant ideas to succeed you need brilliant business models. Google so far has only had one brilliant business model - AdWords. Labour is a cost not an asset!

3. Going public. They had a cash cow with search and little competition. Since they have gone public they have encouraged companies like Microsoft and others to compete now that people know what their earning are. They never needed the money from an IPO. They could have kept the company private and maintained secrecy.

What Google doesn't seem to realize is that companies do not generally come up with tonnes of great ideas. And giving away ideas is never a good idea. Great companies come up with many 3 or 4 great ideas that they focus on. Or sometimes just one idea.

May 28 01:15 AM

[Wizler:]

So far all their revenue diversification efforts have not generated any meaningful profits.....and they are even investing in things like energy, this to me looks like a lack of focus.

Meanwhile you have companies improving on search and using referral sites like Digg. I now use Scoopler for 80% of my searches and get more relevant/current results.

As effective as it currently is, I believe search is still at the level of the green screen days of the internet.

Quick reminder that the switching costs of search for consumers is close to zero....so this giant could fall fast!

May 28 04:28 AM