GOOGLE THIS: “COST CONTROL”
By just about any measure you can think of, Google is one of the most spectacular success stories in the history of business. However, even a company as wealthy as Google has to control its spending. Google’s case is unusual in the sense of its sheer scale, but the story is not unique. When a young company is growing quickly and money is pouring in from sales or from investors, the natural tendency is to focus on building the business and capturing market opportunities. The less exciting—but ultimately no less important—task of creating a sustainable cost structure with rigorous expense management often doesn’t get as much attention in the early years. In some companies, rapid growth in a hot economy can mask serious underlying problems that threaten the long-term viability of the enterprise. In the dot-com boom of the late 1990s, for instance, more than a few high-flying companies fell to earth when investors who had enjoyed a rocket ride in the stock market realized the companies didn’t have workable business models. During the mid-2000s, Google’s revenue had been increasing at a spectacular pace, from $10.6 billion in 2006, to $16.6 billion in 2007, to $21.8 billion in 2008. However, expenses were growing at an even faster rate. As a result, the company’s profit margin dropped from 29 percent in 2006 to around 20 percent in 2008 (still 5 percentage points better than the industry average); 2008 ended with the first-ever drop in quarterly profits in the company’s history. The cooling economy and slowing profits didn’t expose any fatal flaws in the Google business model, but the drop certainly was a wake-up call that emphasized the need to transition to the next stage of organizational development. It was time for the accounting and financial management functions to play a more prominent role and to transform a wild and wooly entrepreneurial success story into a major corporation with stable finances. Back in 2001, Google cofounders Larry Page and Sergey Brin brought in Eric Schmidt, a seasoned technology industry executive, to guide the company’s growth beyond its initial start-up stage. Under Schmidt’s leadership, Google expanded from 200 employees to more than 20,000 and secured its place as one of the world’s most influential companies. In 2008, facing the need for a more methodical approach to accounting and financial management, Schmidt brought in another executive with a proven track record in corporate leadership. Patrick Pichette made his name helping Bell Canada reduce operating expenses by $2 billion, and his proven ability to bring expenses in line with revenue was just what Google needed. Pichette and other executives tackled expenses at three levels: employee perks, staffing, and project investment. It’s safe to say the employee perks at Google are still better than you’ll find just about anywhere, but they have been trimmed back to save money. The company no longer pays for the annual trip, and the $1,000 annual cash bonus was replaced with a $400 smartphone. The 50 percent discount on Google-branded clothes and other products was reduced to 20 percent, and the subsidy on hybrid vehicles was trimmed as well. On the plus side, employees still get free gourmet meals and subsidized concierge services to take some of the hassle out of handling life’s little chores. At the staffing level, Google is taking a much harder look at hiring practices to better align staffing with project needs. Tellingly, the first layoffs in the company’s history, in January 2009, involved 100 recruiters whose services were no longer needed because Google’s hiring rate had slowed so dramatically. Thousands of contract workers were let go as well. The vaunted “20 percent time” was reevaluated, too, with the company deciding to focus engineers’ time more directly on core projects. At the project and program levels, Google is scrutinizing its investments more carefully and pulling the plug on lesspromising activities. Some of the higher-profile shutdowns in the past few years include Lively, a virtual world that would have competed with SecondLife; dMarc Broadcasting, a radio advertising company; Google Wave, a collaboration platform; and Google Labs, which did a lot of the company’s speculative tinkering and experimentation. “More wood behind fewer arrows” is how Google describes its new emphasis on putting its resources into the projects most likely to have sizable longterm success. Pichette leads by example when it comes to cost control, too—flying economy class in North America and riding to work on a bicycle that is so beat up he says he doesn’t even bother to lock it up. While continuing to manage costs more carefully, the company is also stepping up its efforts to generate more revenue. Key areas of focus include expanding the company’s activities in mobile phone advertising and display advertising (graphical ads as opposed to the text-only ads that now appear next to Google searches), expanding Google1 to take on the mighty Facebook in social networking, growing its software and e-book revenue, and continuing to push YouTube toward profitability. To say the effort has been a success would be a bit of an understatement. Expenses are down, and free cash flow is up dramatically. Even after that rough patch when the economy slowed ad sales, Google still ended 2008 with over $20 billion in current assets—and it raised that to almost $30 billion in 2009, over $40 billion in 2010 and headed for $50 billion and beyond. Asked why the company was sitting on so much cash, Pichette explains that in the fast-changing world of search and other digital services, Google might need to jump on an acquisition almost overnight, with potentially billions of dollars of cash in hand. It might not have an infinite supply of money, but with a new focus on careful accounting, Google will have plenty of cash to keep its innovation engine churning out new ideas for years to come.25
1. Given the eventual need for rigorous financial management, should every company have extensive cost controls in place from the first moment of operation? Explain your answer.
2. Google recently had a debt-to-equity ratio of 0.04. Microsoft, one of its key competitors, had a debt-to-equity ratio of 0.15. From a bank’s point of view, which of the two companies is a more attractive loan candidate, based on this ratio? Why?
3. At the end of 2008, Google’s current ratio was 8.77. Midway through 2009, the current ratio was up to 11.91. Does this make Google more or less of a credit risk in the eyes of potential lenders? Why?