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2015-08-18 10:32:29
The internet giant s new corporate structure will provide more clarity for
investors
Aug 15th 2015
THESE days it seems as if there is almost no area of technology that Google can
resist dipping its toes into. Among other things it is working on driverless
cars, delivery drones, glucose-detecting contact lenses for diabetics, devices
for the smart home and research into extending human lifespans. The corporate
reorganisation it announced this week is an acknowledgment of what Google has
become: a sprawling conglomerate, albeit with one predominant,
profit-generating division in the form of its original internet business.
Google s founders, Larry Page and Sergey Brin, will serve as chief executive
and president, respectively, of a new holding company, called Alphabet. Google
s internet-search and advertising business, including its YouTube online-video
service, Chrome web browser and Android operating system, will be a subsidiary
of Alphabet. So will its other, newer ventures, which will henceforth be run
more independently from the main business. In creating this new set-up, Messrs
Page and Brin are taking inspiration from Berkshire Hathaway, a successful
conglomerate that invests in more established industries (see article, and
Schumpeter).
In practical terms, the two founders will be freer to spend time on emerging
business lines that tickle their fancy. The group s main moneymaking activity
which last year produced 89% of its $66 billion in revenues will be overseen by
Sundar Pichai, a well-liked veteran Googler. An engineer, he understands the
firm s internet and advertising products well, and can concentrate on driving
improvements in them. The heads of the other units will report directly to Mr
Page, and be able to ask for more investment or support without navigating the
bureaucracy of Google s core business. (Eric Schmidt, who will be Alphabet s
chairman, is on the board of The Economist s parent company.)
The new structure will also bring more transparency, pleasing shareholders fed
up with the firm s opacity. Google can serve up search results on any subject
in fractions of a second, but it has been slow in providing detail on its own
businesses. For example, no one outside Google knows whether YouTube, which
Google bought in 2006, is profitable. Nor is anyone certain how much it is
pumping into its moon-shots , its speculative research projects. All they
have done every quarter is offer investors assurances that their spending is
controlled and proportional, but now we are going to be able to see if it is,
says Peter Stabler, an analyst at Wells Fargo Securities. The day after Google
s announcement, its shares gained over 4%. Likewise, Amazon, another secretive
web giant, got a boost to its share price when it released more detail about
its cloud-computing business in April.
Mr Page quipped that one reason they chose the name Alphabet was because they
strive to make the group an alpha bet , that is, one that will outperform the
market. For now, outperformance looks likely. Google s internet operation has
successfully anticipated shifts in consumer demand, such as the rise of mobile
devices and the growing popularity of online video. Few firms can claim such a
lucrative core business: Google s advertising operation probably has profit
margins of more than 60%, reckons RBC Capital, an investment bank, and it gets
more than 70% of all worldwide online-search revenues.
However, the need for a new corporate structure reflects its transformation
into a mature company, with the challenges that brings. The European Commission
accuses Google of abusing its dominance of the online-advertising market by
favouring its own products in search results. Google is due to respond to the
charges soon. Meanwhile, even Google s most devout boosters are anxious to see
proof each quarter that its impressive growth rate can continue unabated. Ads
on the small screens of mobile phones are not as lucrative as desktop
advertisements, and could be a drag on margins in the future.
In the longer term Alphabet will also have to prove that its various dream
factories can turn into viable businesses. In setting them up as stand-alone
companies, Messrs Page and Brin have raised hopes that they are getting close
to being commercialised. But so far, with the exception of a smallish business
that provides fibre-optic broadband service and Nest, a maker of smart
thermostats that was bought last year for $3.2 billion, the group s newer
initiatives have no revenues, according to Mr Stabler of Wells Fargo
Securities.
Many technology firms have tried to exploit promising new ideas, only to see
them stifled by the existing, profitable core business Microsoft being one
example. In creating the holding company and liberating their moon-shot
ventures from the main internet business, Messrs Page and Brin are seeking to
avoid this fate. Turning them into formal subsidiaries could be a step towards
spinning off the successful ones, if that is the chosen outcome for them. It
also makes it harder quietly to sideline those that do not pan out. In either
case, the expectation is that Alphabet will spell things out more clearly.
Correction: Google's smart contact lens detects levels of glucose, not insulin,
as we originally said. The article has been changed accordingly