Google, Earnings, and the Future of Disruption
Google announced earnings last week. The company is successful, with roughly equal revenue to Comcast at a higher margin. The stock market on the other hand reacted negatively, with Google (or should I say Alphabet) shares dropping five percent. But what does this really mean?
Google has two divisions that make real money: the search advertising business and the home thermostat division. The ad business is strong. There are two problems, first Google spends a great deal of money on research on projects that might become something in the future. These are the “moon shots.” This is an apt name as the moon shot cost a great deal and yielded little. Developing these projects is interesting, but not the sort of thing that a strong company does for longterm stability.
Second, more worrisome for Google is increasing traffic acquisition costs. Some people click onto Google for their general purpose searching. In many other cases, users are pushed toward Google by device manufacturers and other companies. This is a really important point — Google is buying and selling user traffic. Hopefully, their time with Google yields clicks that can be monetized. Users in this world are not deciding which service to use based on search quality, but ease of interface. The core search product and traffic routing process is the heart of the business. Upstream parties, like phone developers, will increasingly isolate the arbitrage condition for traffic by forcing Google to lower the margin on traffic routing. To stay ahead of this, Google will need to organically generate traffic or continue to improve the search product.
What would Clay Christensen do?
According to the basic theory of the leading light of disruption, new firms can enter a market by providing a minimally sufficient replacement for an existing product or by providing marginally inferior products in superior formats. Thus, inferior quality steel can be substituted when top quality is not needed. New insulin injectors can replace better insulin in syringes. Firms are captured by resource dependence, demand and cash flow being resources, precluding them from making moves that could be disruptive on their own. What would the alternative be? To invest in alternative projects. Google subsidizes their moonshots with cash from the other divisions.
But is this really good for the economy?
Fixed income investments are getting hard to find. Massive corporate cash piles. Why not pay a dividend? At least Google spends some of them, unlike firms that hoard money. Is continuing to circulate cash through the economy too old fashioned for Silicon Valley? Luckily Americans are moving away from buying individual equities, so it is possible that larger instruments can translate these price movements into regular cash flows. At the same time, why run that cash through such a clumsy instrument? Instead of either distributing the money through dividends or potentially taxing corporate income, we pay those rents to the financial sector to facilitate what were once the basic functions of the stock market? Super. Just super.
Beyond issues with the decline of dividend bearing securities, Google may be surprising rather than aiding innovation by subsidizing moonshots. There are many self-driving car projects in this world. Traditional motor companies will likely win the self-driving car race. Tesla needs the business compression of pre-orders to stay afloat, Cadillac will have self-driving cars on the road in nine months. Chevy won’t be far behind. Toyota is in rapid self-driving technology development. Volkswagen has already passed major self-driving milestones. Unless Google transfers a great deal of cash from search to the car division, they will not be able to catch up to Tesla, much less the world auto industry. Why should other electric car companies even bother to build best practices or meaningful operations when Google might try to flood their market with cash from search? The Google cars look terrible, if they added a puppet driver these would be stage props from Idiocracy. Even if self-driving cars become popular, these aren’t going to be the winners.
The reporters coming to the Google self-driving car launch event will be arriving in self-driving cars from Toyota, Volkswagen, and General Motors. Silicon Valley executives won’t notice because they will have spent at least three years in a seminar on disruption.
In recent years the Justice department has been all too willing to allow companies to get away with anti-competitive practices as long as the impact is not expressed in consumer price manipulation. The point of Christensen’s disruption is that firms in dominant positions may not be able to appreciate the possible disruptive businesses around their established circumstances. Google’s moonshot divisions could just as easily be inhibiting the formation of down market operations. Anti-competition law should take note of the ways in which rapidly expanding cross-subsidies by large corporations could create deformations that might stifle the formation of new markets, even if there are ostensibly pro-consumer effects in those subsidies. What kind of massive subsidies will Google need to offer on inferior cars to get customers to leave their already familiar self-driving options from the major car companies?
Subsidizing downmarket cell phone carriers to disrupt Verizon and AT&T (another moonshot) might seem good for some customers, but could have chilling effects on infrastructure investment. After all, if data is cheaper more traffic could be routed through Google which means more search revenue which means more subsidies, with of course Google working on new generations of phones that might displace the existing android install base as they would need to cut out any middle men and recover their arbitrage income on traffic routing cost. The impact here is likely minimal — after all AT&T and Verizon are each twice Google’s size. Google’s effort makes sense, but it simply doesn’t have enough money to actually change the equilibrium price for data access, especially when the featured networks in their program are Sprint and T-Mobile. As for the phones, the flagship wars are ending, phones will be getting cheaper and Google has already been flanked by the iPhone SE. These moonshots aren’t getting out of the atmosphere. Investors could be responding to these moonshots with a deliberate, meh.
Wearables and contacts. Samsung is working in this space, as are others. After Theranos, there will be some real skepticism about tech companies darting into the medical space. There is something very 2006 about a smart-shirt as the future of Google. That isn’t a good thing.
Immortality research is interesting, but not likely to have a meaningful result. Many of Google’s other projects are intended to increase data use and thus potential profits, this project would increase the total amount of life, thus internet use and profits.
Google has become something of an institutionalized disruptor. Once firms are free of the need to support shareholders they might push capital in all sorts of interesting directions. In the case of Google, it is clear that most of their moonshot projects are tied to pushing more activity through google ad platforms. In this sense, the moonshots are not necessarily problematic, but they are annoying in a world where attention is limited and clicks are decreasing. Shareholders could be pointing to the end of disruption — Google is running Christensen’s playbook perfectly, yet not reaping mega-profits and changing the game. So far Google’s efforts have focused on driving additional volume through their established business pathway. It seems possible that the real
Unless Google’s efforts in other related sectors pick-up steam, it seems possible that the rising cost of arbitrage will begin to cut away at their profitability. Investors mehs may turn into angry grunts as Google’s margin shrinks and the practice of institutional disruption turns out to be not that disruptive at all.