Why Eric Schmidt had to go: Google's innovation dilemma

Charles Arthur provides a convincing back-story to the Google exec re-shuffle.

Google shuffle: why Eric Schmidt had to be pushed from the top | Technology |

There is evidence of execution failure and indecision or muddled messages to stakeholders. Shared leadership arrangements never end well.

But in this forum I’ve been critical of their strategy. Though I’ll be the first to admit that such criticism is not founded on data but on intuition, strategy is always made in a vacuum of data. It is just an unfortunate fact of life that we don’t have data about the future.

But what data we do have is about the past and it shows the contrast between Apple and Google.

As a sample, let’s look at the performance in the last quarter:

Growth Google Apple
Revenue 26% 70%
Earnings 29% 75%
P/E 24.13 18.57

Apple grew about 2.5x faster. The companies are in very different businesses, but the money they make is the same color. The investors have been paying attention:

Source: Google Finance.

In 2005 and 2006, Apple and Google were neck-and-neck in terms of returns to shareholders. However, with the iPhone’s arrival in 2007 the stocks diverged. Google gained 38% since January 2007 while Apple gained 300%.

However, going forward, the market is kinder to Google than to Apple, punishing Apple’s 75% growth with a P/E of 18 (ex-cash 15) and rewarding Google’s 29% growth with a P/E of 24 (22.5 ex-cash) . Although Google’s P/E is proportionate relative to its growth, Apple’s P/E implies deep pessimism.

But does Google’s performance suggest management failure? Certainly not. It’s been a great performance. Google is arguably at the top of its game. Market share of search has never been better.

Cracks in strategy are hard to spot. One hint is that most of Google’s R&D efforts are defensive. Building browsers and mobile operating systems are methods to ensure they have distribution of search to as many screens as possible. These are expensive means to ensure channels are available for distribution. Expensive not only in terms of engineering costs but also in terms of relationships and opportunity costs.

But even a defensive posture is not sufficient for management change.  What I think is the most serious failure is that for the past five years Google has not addressed the possibility of search itself becoming commoditized. Social media and app economies are asymmetric to search. They make money in different ways and appear to be less efficient or effective means to reach users, but they are growing. Facebook has overtaken Google in terms of page views and apps are a new interaction model for cloud-based content that does away with the indexing model Google champions.

The real condemnation of the leadership at Google is that there has been a failure to create entirely new disruptions. As the stock chart above confirms, Android and Chrome are, if successful, sustaining technologies for Google. That’s not going to be enough.

  • The point you make does indeed make sense. The thing that would make me nervous as a Google shareholder is that the companies revenue is still highly dependent on search ads. After 10 years and with the size of Google I would expect the company to diversify it's revenue streams. Yes there is AdSense and the AdMob acquisition and Google Apps but the core of Googles revenue is still search. If this paradigm would be disrupted the company could run into trouble.

  • Bob Shaw

    To build mobile operating system in the hyper competitive smart phone and tablet markets is a pretty expensive way to ensure that channels are available for distribution. More over it hurts relationship with other players who may feel very insecure and thus may build their own defenses against Google. Finally it is very expensive to keep upgrading the mobile operating system in this hyper competitive market. All in all the cost is just not financial but also future lost opportunities due to damage to relationships. Google should have found some creative option to ensure that channels are available for distribution.

    • chano

      Except that they did not build that much, it seems they stole core aspects of Android as Oracle have informed them.

  • Sameer

    i think .. IMHO.. this change might witness a fundamental shift in Google's product strategy where all new products are not designed with a strategy to monetized via search / Adsense..

    we might see new revenue models in place soon – for eg Google Offers / Content play / etc etc..

  • sha

    so according to you, any tech company in the world (you know, the ones NOT doing 75% YoY for the last 3 years) should fire their CEO right now ?

    • asymco

      No, I said that the current growth (29%) is not a reason to change management. I further said that a defensive posture is not condemnation. I concluded that a lack of new growth initiatives in disruptive areas asymmetric to their core is a good reason to change management.

      • sha

        fair enough, but then I don't see the point to compare with Apple's performance :p Everybody knows Google stock is flat since 2007

      • Danthemason

        And now you have an explanation for "why" , which was the point of the piece.

  • Thomas65807

    Jim Cramer, the stock analyst on CNBC, said tonight that the reason Apple's stock dropped off after the company announced earnings was that it had already run up by a lot in the preceding weeks on expectations of a great earnings report … not because of the deep pessimism mentioned in this article.

    What I found interesting/amusing about the Google earnings report was that Google's gross REVENUES are about the same dollar value (a little over $6 billion) as Apple's PROFITS. Apple revenues were well over $20 billion, or 3-4 times Google's.

    Personally, I am getting tired of getting all of the crappy search results when I use Google's search engine. I believe in free markets and respect Google's right to sell the top search results to advertisers … but I also believe in the right of consumers to rely on another company for their searches.

    • arjun_

      Jim Cramer, I hope for the day that people stop listening to him. Pessimism is implied by the valuation multiple, has nothing to do with run ups and run downs, really.

    • capablanca

      Because Apple is a hardware company and Google is not, revenue comparisons should be avoided for most purposes. Better to compare the respective dollar amounts of gross margin, operation margin, and net profit. Apples to Apples. 🙂

  • Jon T

    Is this also something to do with the Oracle lawsuit against Googldroid software?

    Or are "partners" who freeloaded on Googledroid expressing their discomfiture at being sued to Google?

    Or, are the regular comparisons of Google being the new Microsoft hitting home?

  • You said: "But does Google’s performance suggest management failure? Certainly not. " I think the failure wasn't in Google's share performance but more it's failure to be the kind of company Larry and Serge envisioned.

    The NYTimes reported that Larry Page said in a telephone interview: "“One of the primary goals I have is to get Google to be a big company that has the nimbleness and soul and passion and speed of a start-up,"

    It sounds to me like it was felt that under ES the company was no longer nimble and had become soulless and passionless. If that was something that could be fixed with party candles or fireworks display they would have done that but what they did was move Eric Schmidt into a position of seeming irrelevancy. So the reason for the lack of nimbleness, soul and passion was ES and was not structural. If their issue was that they didn't only have one person as the "go to" person as was also reported, they could have simply said, ES is the go-to person. But they didn't. They moved ES out and put him in charge "technology thought leadership".

    Eric Schmidt led Google through the rapid growth years when the advertising revenue stream must have seemed endlessly lucrative. ES floated up with that tide. But for a company which probably envies Apple's continual Y/Y revenue growth and innovation and has similar expectations for itself the past several years must have seemed languorous. It was ultimately Serge and Larry's call on what to do and their solution says a lot.

    • Steven Noyes

      My problem with this is the assumption Sergy and Larry have been doing nothing while Eric has been in charge of all innovation and direction. Perhaps S&L spend their days playing video games but I seriously doubt that.

      While Larry Page be able to kickstart new innovations with just a title change?

  • Hamourabi

    Google management team may come to realize that android is running into a wall and that more generally the frontal confrontation with Apple strategy is a bound to fail. Hence some internal conflicts within the triumvirate.

  • hahnchen

    Android is a lot more powerful than a "sustaining technology".

    Charles Arthur's piece is fairly poor. He offers little insight, quoting twitter feeds. He cites a failure in corporate culture, and places the blame on Schmidt. But is that the case? Do you really think corporate culture will change now that Page is in charge? Is he going to curb 20% time and make everyone work on generating ads?

    The hell he will, it's long been known that Google were run as a triumvirate anyway, so there will be no big change. What I think will happen though, is that Schmidt will be able to lobby harder and higher without the CEO spotlight being on him.

    • pk de cville

      "Android is a lot more powerful than a "sustaining technology"."

      It's appearing worse than that to me. They're not making money on it. It's purpose seems to have been to create competition for the iPhone for fear of being dominated by Apple in mobile advertising.

      I think ES was given a seat on Apple's board because Jobs and ES wanted to forge a partnership: iPhones everywhere, Google Ads on iPhones everywhere. Someone screwed up in the trust department though and Android pissed in Apple's garden.

      In a few years, Android may be seen as one of the greatest strategic mistakes in corporate history! Notice that Samsung has forked it's own Android variant, Baidu – Samsung will use the Baidu brand to compete w/ the Android brand. And how long will it take Samsung to take ad $$$ from Google?

      And Verizon just replaced Google search with Bing! These two are just the 1st of dozens of companies which will take free and open Android and use it to kill Google!

      (This may be why ES is not in the loop any longer.)

      • hahnchen

        Android is making money already. That is, unless you believe making money equates to selling licenses.

        Do you not think that Google envisaged fragmentation of the Android ecosystem given its openness?

        Samsung Bada is a no-go, even the Koreans have picked Android over that. Google Android may lose out in markets such as China to a Baidu variant, that's a risk.

        Android isn't just sustaining search, it's growing it, and delivering local ads, something that was difficult to do on PC. It's also a platform from which they can launch new products, which is something no one has properly grasped yet. Sure, they fucked up with Buzz, but what if Android 3 comes with Google Social?

      • famousringo

        Android may be making money, but is it paying for its development and all its opportunity costs? It turned a partner into a competitor, provided an escape hatch which allows Microsoft to replace Google with Bing, enabled millions of cheap devices with no Google services whatsoever, and provoked a lawsuit from Oracle.

        Surely Google could have made a compelling product which didn't empower rivals and alienate allies?

      • Steven Noyes

        You miss the point.

        Google also makes money on iOS through search. Android was born of fear from WinMo (hard to believe now. How the mighty can fall) and Microsoft/Bing getting to the mobile search pie first. If Google had foreseen iOS becoming dominate, they would have just let it go. Google Maps on iOS, GMail, YouTube… Dude, iOS is a Google haven of mobile search and advertising revenue.

        So you have to ask. If Google has to spend $0.10/unit on iOS to get $1.00 in return but have to spend $0.80/units on Android to get $1.00 return, which is the better company strategy?

        And to answer your question:
        Do you not think that Google envisaged fragmentation of the Android ecosystem given its openness?

        Nope. They did not. They lack the maturity in software to have invisaged the outcome.

      • davel

        very good points

      • poke

        "Do you not think that Google envisaged fragmentation of the Android ecosystem given its openness?"

        Absolutely. I don't think Google cares either way about fragmentation and I think they're perfectly aware that their talk of "openness" is shallow and self-serving. The goal of Android is to keep the mobile market open to Google, in the sense that nobody will be able to dominate and shut them out. Fragmentation is absolutely not their concern, user experience is absolutely not their concern. Diversity is their concern. Sucking value out of the market is their concern. Even if Samsung has a version and HTC has a version and Motorola has a version, Google has achieved its goal. There's no evidence that Google cares about the fragmentation issue at all.

        Of course, the neat thing about saying the purpose of Android is to grow search and ad revenue is that Google controls that data, it's near-impossible to determine the effect of Android on it and Google can claim pretty much whatever it likes about the outcome. As long as Google's cash-cow keeps bringing in money and as long as they don't bet on an actual product that could succeed or fail in the market in the usual way (i.e., by determinately not making enough money), they're immune to the consequences of their own mistakes. That's disturbing.

    • asymco

      Android may be disruptive to the mobile phone industry (though there are some reasons to doubt that) but I'm stating that it's sustaining *to Google*. They are treating it as a way to improve their current business. What Google needs to seek out is something that is disruptive to themselves. They need to find a way to kill search.

  • The reason the market grants a lower pe to Apple is that Android is free which will eventually erode the margin of iOS. Short term (1-5 years), that is not a problem but it is a long term challenge to Apple.

    • chano

      That does not compute in the real world. An integrated product is always superior if its maker has a clue. Apple is the only phone-maker with a clue and with an integrated product.
      Google's problem is the same as Microsoft's experience during the last 10+ years. Even if it is free, there is no long term success for phone=makers who use Android. It is a price war to bottom-dwelling. Ask Dell and all the rest who are serial failures in their efforts to differentiate themselves and earn a crust. Meanwhile Apple can sell fewer units but still make more profit than all its competitors combined. You don't ride astride such a commercial paradox by accident.
      Your suggestion is either based on missing the point altogether, or idle mischief-making.

    • dchu220

      I think the market grants a better PE because people are more comfortable with monopolies. Everyone preaches about creating shareholder value through innovation, but in the end, monopolies are seen as safer.

    • asymco

      I hear this many times, but I hear more often that the market does not care about the long term.

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  • CndnRschr

    Android is only valuable to Google if it has significant control over the OS to capture page views for its ad business. As we've seen, the telcos are quite happy to flip a finger at Google and substitute Bing as the default search. Moreover, paid apps circumvent advertising entirely. Sure, Android is predicated on free apps with lots of ads but at some point, the advertising may become intolerable to some users or is ineffective for the advertiser. Why do people pay for premium cable? A mix of better content and no ads. As Android devices race to the bottom, so with the purchasing demographic. This will mean a drop in per view revenues since the target audience will have less income. It's not a linear relationship, but is akin to the narrowing of margins in PCs. You can make that up by volume, potentially, but supporting 10X or 50X the user base for the same revenue for developers is not sustainable.

  • Apple only has the iPhone, which is the biggest scam in the history of consumer electronics.

    It costs $150 to make, and Apple has sold tens of millions at $600 through carriers. The biggest profit margin in the history of consumer electronics.

    Thanks to Android, now we are seing Android phones sold at sub-$150 prices on pre-paid or even totally unlocked. This is the end of the iphone scam era and Apple is desperately trying to find another cash cow. They won't find it. And much faster than Apple stock went up since 2007, it will go down and they have to spend every dollar they have in the bank just to keep things going.

    If you are an Apple share holder, take your money and run while you are on top.

    • cjackson

      Clearly you're living in a different reality than the rest of us. I know you're just trolling, but may I suggest that you try the Engadget comments section? They're much better at feeding trolls over there.

      • raycote

        How true that is !

        That is what make this blog so refreshing. You get to feed your head instead of the trolls.

      • Atul Barry


    • arjun_

      Ah, Nicolas.
      Charbax has breached the final frontier, and will now start hounding asymco readers with baseless assumptions and borderline vitriolic comments.

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  • Walt French

    Well, we’d ALL love to have presided over Apple-like success, so I guess it’s a decent standard. But in fact, no other firm has powered its way to the top so forcefully. Blaming Schmidt for Google’s failure to do so seems a tad disingenuous.

    Ultimately, I believe that business success is about delighting customers, and Google’s customers are the ad-buyers—marketing departments and small businesspeople, not those of us whose eyeballs are for sale. Google’s failure to come out with transformational products, as Apple has, is in part the much greater complexity of substantial leaps in connecting and organizing the incredibly complex information of consumers’ commercial needs.

    All of Google’s beta projects seem oriented at adding to that incremental ball of yarn, under the assumption that someday they’ll someday figure out how to disentangle it. As I think they likely will. With their incredible database of likes, wants, curiosities, locations etc., who better than Google to surpass Netflix in guiding us to what we really want, not just who pays most for “Gaggia” ?

    We stock market types like to believe markets are incredibly efficient, but information in the retail landscape is incredibly hodgepodge, hard to come by and expensive today. Google, or perhaps Amazon or facebook is in the best place to use their current resources to cut Peets’s cost of handing me my cappuccino when I emerge from bart every 5:15AM, of sending me to the market with plenty of fresh crab; of letting my friend know that I’ll like What I Think About When I Think About Running.

  • The disparity between Google's and Apple's P/E is relatively new, rising from Apple's stellar results this quarter, which brought their P/E down from the 22-23 range to the current 18 and change. The market simply hasn't caught up, or doesn't want to catch up because of concerns over Steve Jobs' health. Based on revenue and earnings growth, Apple most likely should carry a higher P/E than Google, so by this measure it can be seen as compressed.

  • I don't know. why does google always have to be comared to apple. they only compete really in phones right now. apple is a one of a kind company. no company really can compare to what it has done under jobs the last few years. it strikes me as missing the mark. google is an immensely profitable growing company with a great future. it's not a crime that's it's "not" apple.

    • asymco

      I don't think I said it's a crime at all. I'm just trying to find a clue to why the CEO of what you call "an immensely profitable growing company with a great future" was fired.

  • yet another steve

    Of course Apple's recent year growth can't be the standards companies are held to.

    But for all it's hoopla, Horace is right: all of Google's recent "successes" are just defensive to protect search advertising revenue. That doesn't mean Android, Chrome and the Chrome OSes aren't great. It means that if search goes into decline all of Google's business goes into decline. I see it similar to Java: Java was an incredible success… but as Sun's business declined it provided no help because it was just a defensive play to protect Sun's business from MS.

    What I believe has forged Apple into such a force in the second Steve Jobs era is the lack of any monopoly-based cash flow machines. On his return SJ killed all the "science" projects. Apple's only business with monopoly power–the ipod–was heading towards being disrupted (by phones) and Apple saw it coming did the disrupting itself. Apple hasn't had a "fat of the land" from a big monopoly to weak business case projects.

    It's just as well that only Apple has this discipline. Imagine how formidable GOOG or MSFT would be with Steve Jobs like focus.

  • ljp

    Maybe they’re just keeping Schmidt around so he can take the hit if Google loses the Oracle lawsuit?

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  • I see the problem with 'social'.

    But apps?
    Google makes great and popular apps.
    Also, I can't see why people would prefer to choose 1 of 20 apps in order to gain information,
    instead of just using 1 (i.e. search).

    So what need to be improved about search is,
    quick display of information, and I see efforts on that direction.

    On the total I agree, Google failed to disrupt (since Gmail and Maps, I think).

    • dchu220

      The problem with search is that you need to know what you are looking for.

      Isn't that part of the reason why you use twitter? It's a another medium by which to get content.

  • And one more thing,
    saying that Google revenue should be more diverse than just Adds
    is like say that Apple revenue should be more diverse than just selling Consumer Electronics
    (i.e. Bullshit).

    • dchu220

      Actually, the argument is that Google needs to be willing to cannibalize search revenue. The moves they are making in the market are based on supporting search. Someday, something will come along and attenuate the profitability of search. When that happens, the whole house of Google will tumble down. In comparison, Apple has been willing to cannibalize the iPod and the Mac with the iPhone and iPad.

      • I don't have problems with issues with that argument.
        (but Google did go into social).

  • dchu220

    That's my point. Twitter is mainly an App-based content delivery system. People spend more time on twitter on their phones than on the PC.

    I believe your argument was that a person only needed search to get information.

  • I never understood why Docs is so poor. No way compatible in offices to Microsoft. Google simply doesn´t understand companies.

    In Holland about 90% of what we doe is governed by politics. No way end users have the same influence. First our government taxes about 70% Then we pay about 70% of our income to food, living and transportation.

    End consumers influence is about 10% of their income. Enough if you want to earn your money. I'd like to change Google view on busieness and government. If you like it or not they control about 90% of your income.

    Personally I don't mind. We share and live together. We don't live in a jungle.

    Nevertheless. I would like more focus from Google to government and business.

    Improve docs dramatically. Focus on business and government. Improve your performance.

    Docs is a joke.

  • LTMP

    I can't remember the last time I used search to find a restaurant or, for that matter, any nearby service.
    I use one of a few apps on my phone, such as UrbanSpoon or Around Me.

    They offer better results, full integration with my phone, and less crappy returns.

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