Google juggernaut gears down for tougher times

Published December 5, 2008 5:23 pm
This is an archived article that was published on sltrib.com in 2008, and information in the article may be outdated. It is provided only for personal research purposes and may not be reprinted.

Corporate austerity is reaching one of the most extravagant spenders of the boom years. Google Inc. has begun to tighten its belt.

For much of its 10-year history, Google spent money at a pace that was the marvel of Silicon Valley. It hired by the thousands and dished out generous perks, including three free meals a day, free doctors, ski trips and laundry facilities, and subsidized personal trainers. It let engineers spend 20 percent of their time pursuing pet projects. The company's goal was to develop new products that would reduce its nearly total reliance on selling ads connected to Internet searches.

But revenue growth has slowed dramatically over the past year. Products such as Google Checkout, a Web payment service, and Google TV Ads, which sells television advertising time, haven't generated significant revenue, leaving online ads still accounting for 97 percent of revenue. Google's share price has fallen to the $275 range on the NASDAQ Stock Market, less than half its record close of $741.79 in November 2007.

So with the U.S. economy in a recession, Google is ratcheting back spending and cutting new projects in what might provide a cautionary tale for the rest of the high-tech industry.

"We have to behave as though we don't know" what's going to happen, said Google CEO Eric Schmidt. The company will curtail the "dark matter," projects that "haven't really caught on" and "aren't really that exciting." He said the company is "not going to give" an engineer 20 people to work with on certain experimental projects anymore. "When the cycle comes back, we will be able to fund his brilliant vision."

Last month, it pulled the plug on SearchMash, a Web site it used to experiment with new ways to organize search results. This month, it plans to do the same with Lively, a "virtual world" launched this summer where online users can create characters and rooms for them to hang out in. Google explained that it wants to "prioritize our resources and focus more on our core search, ads and apps business."

Google's years of rapid growth were fueled almost entirely by a single business -- sales of search ads, the small text ads that appear next to search results cranked out by its Internet search engine. The company realized that the torrid growth couldn't continue forever. So far, it hasn't come up with any big new revenue streams.

"Letting a thousand flowers bloom and letting many of them stall and go nowhere has worked well to this point," said Thomas Eisenmann, a professor at Harvard Business School. "But if you want to be the dominant advertising network across every medium, you need more top-down management."

Google executives say they started preparing for slower growth more than a year ago. But the economic crisis is forcing them to step up their efforts.

In recent weeks, Schmidt has conducted meetings with top executives to determine where to focus investment more narrowly. Top priorities include display ads, which use graphics and appear on Web pages; advertising on mobile phones; and the company's online business software.

Schmidt says the company is shifting more engineering and sales resources to those areas, and away from less-promising projects. This fall, the company announced plans to "significantly" reduce its roughly 10,000 contract workers, whose jobs range from engineering to food services. Although the timing and focus of the cuts remain unclear, Google employees already are joking that it's getting easier to find a spot in the company's crowded parking lots.

Google has also begun chipping away at perks. In recent months, it reduced the hours of its free cafeteria service and suspended the traditional afternoon tea in its New York office. A Google spokesman said its core culture is not changing. "Our unique culture is an essential part of what makes Google Google."

Google is coping with a problem that has befallen other tech companies before it, from Microsoft Corp. to eBay Inc. -- adjusting to the end of runaway growth. Revenue grew by a robust 31 percent in the third quarter from a year earlier, but that's down from 92 percent annual growth in 2005. Still, with $14 billion in cash and roughly 30 percent of the U.S. online-ad market, Google is in a much better position than its competitors to withstand this downturn, Wall Street analysts say.

Nevertheless, the internal changes represent a big shift for Google. Early in its life, the company said that it would always put long-term objectives ahead of shareholders' short-term interests. It wooed the best engineers with generous perks, workplaces that feature pool tables and volleyball courts, and a promise they could spend time pursuing side projects.

Inside the company, it was considered crass to talk about whether a project would eventually make money, say current and former product engineers. The measure that mattered most was whether a new idea would be good for the Internet user's experience.

That anything-goes culture fostered thousands of projects. The company launched a program to digitize and search millions of books; Google Earth for browsing satellite images; and a way to get answers to search queries via text messages on mobile phones. Some, such as Google's e-mail service, called Gmail, became big hits. Many others, such as experiments with offering digital music and an online data-storage service, never took off.

The failures didn't matter much when money was rolling in:.Revenue grew 92 percent in 2005 and 73 percent in 2006. But in July 2007, the company said it had overspent on hiring, causing second-quarter operating income to fall from the prior quarter, a rare misstep. Even so, revenue grew by 56 percent that year.

Google hired a new vice president of financial planning and analysis, Francois Delepine, who sought to standardize and more tightly manage the budget process. Finance teams started allocating more new hires to groups that generated the most revenue per head, say people familiar with the matter. To better predict revenue, the company implemented quotas for ad-sales representatives and tied the pay of more employees to performance, these people said. Different departments were required to budget the same amount for the same item, whether it was a server computer or a business-class ticket to Europe.

The company stopped the pell-mell hiring of virtually any employee who met its qualifications, focusing instead on adding heads only where they were needed. Hiring slowed to 889 new employees in the fourth quarter of last year, down from around 1,300 in the year-earlier period.

In last year's fourth quarter, the company's revenue and profit fell short of analysts' expectations, amplifying concerns about the impact of an economic slowdown on online advertising. But the company's profit jumped 30 percent in the first quarter and 35 percent in the second as it continued to steal search-market share from competitors. Google said it had not yet felt any impact from the weakening economy. It was well-positioned to continue to thrive, it argued, because its search ads provided the best, and the most measurable, return for advertisers.

But U.S. Internet-advertising revenues for the industry totaled $5.9 billion in the third quarter, up just 2 percent from the prior quarter, according to the Interactive Advertising Bureau. Google said during a recent earnings call that it is seeing weaker spending from auto-financing, home-financing and real-estate advertisers.

The financial crisis has created a new sense of urgency within the company. Earlier this year, managers underwent an operational review of Google's sprawling real-estate footprint. For years, the company elected to open offices wherever it felt it could find talented engineers. That often led to multiple offices around relatively small markets such as college towns. To reduce overlap, in July the company said it was closing an office in Dallas and another in Denver, saying it already had at least two offices in each market.

Google recently hired a new chief financial officer, Patrick Pichette. Trained in "Six Sigma" management practices -- a rigid quality-control system designed to eliminate waste -- Pichette is looking to reduce inefficiencies and delay spending when possible.

There is some evidence that Google's efforts are starting to pay off. In October, rivals such as Yahoo and eBay announced layoffs after issuing grim third-quarter results. Google beat analysts' diminished expectations, largely because of tight cost controls. "There's a lot more we can do," said Schmidt at the time.

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