The journey from Google (GOOG) (GOOGL) to Alphabet has seen ups and downs. Innovation needs time and patience, with no certainty of the future, which can make investors apprehensive. For Alphabet, its co-founders satisfied investors without compromising on their great tech dream. Let’s look at Alphabet’s story in detail.
The way of the co-founders
Since the very beginning, Google co-founders Larry Page and Sergey Brin were stubborn entrepreneurs with strong opinions. Earlier this month, The Verge described instances where the duo has made gutsy calls, from opposing search engine advertising and firing all Google project managers to Page’s acquisition of Android without informing then-CEO Eric Schmidt.
Throughout it all, they maintained their vision to develop technology that would change humankind. This aim was at the forefront when they developed Google’s search engine. The company’s Google X, Calico, and Verily Life Sciences platforms also share this aim.
Co-founders think ABC
Page’s and Brin’s first ten years at Google were exciting, bringing challenges, new products to develop, and strategies to execute. The co-founders’ much-awaited decade from 2000 to 2010 saw the commercialization of digital advertisements, major acquisitions, and the launch of Google’s web browser, Chrome. With the launch of Chrome, Google became an end-to-end provider of browsing services. Google also entered the smartphone segment with its operating system, Android One, and boosted its online ad business through YouTube.
Page and Brin played a major role in these developments, giving them a great sense of achievement. The business picked up the pace and generated massive revenue. By the end of the first decade of 2000, most of Google’s money-making segments had established momentum. Its revenue grew from $6 billion in 2005 to $29.3 billion in 2010. With few possibilities for innovation left in these segments, the co-founders were confined to supervisory roles.
Bored of being boxed up and filled with capital, the co-founders revived their exploring zest and launched Google X in 2010. In a 2015 investor letter, Page wrote, “Sergey and I are seriously in the business of starting new things. Alphabet will also include our X lab, which incubates new efforts like Wing, our drone delivery effort. We are also stoked about growing our investment arms, Ventures and Capital, as part of this new structure.”
Investors think XYZ
Google stock grew almost tenfold from $54 in 2004 to over $500 by the end of 2014, before the restructuring of Google. Investors seemed optimistic about Google as a search engine and advertising entity. They may have expected that any acquisitions made must support Google’s core business. Also, as many may have been hoping that the co-founders would stick to their original business, the reasoning for adding Google X to its portfolio may have been unclear to investors. Internet balloon and life science projects were certainly not expected from the browsing giant.
The Google X move may have made investors paranoid about investing in Google. In July 2016, wrote, “While investors still do not know X’s budget, they at least have a sense of the limits. In the first quarter, Alphabet lost about $800 million on what it called “other bets” — everything outside Google’s core search and advertising businesses.”of The New York Times
Investors’ reactions to Google Other Bets
Google’s core business made investors feel secure about their money. Chrome, Gmail, and Android had market demand and the scope to grow exponentially. However, Google X was so out of the box that it had no dependable working infrastructure. Anything created through Google X would require end-to-end development. Moreover, such moonshot projects couldn’t justify the consumer base. There was also no guarantee that the capital invested would churn out satisfactory returns. Some of Google’s projects selected for research were so unrealistic that they irritated investors.
In his 2016 article, referring to Google X, “shareholders’ perceptions about the division were aptly summed up by a poster board in its Mountain View, Calif., offices. It had a picture of a burning $100 bill followed by, ‘Investors think we do this.’”
Stockholders’ biggest concern was the feasibility of such unrealistic projects and their ability to generate revenue. They feared that Google’s profit from search and advertisements would be used to compensate for losses by unruly subsidiaries. In Other Bets, Google lost more than $3.5 billion in 2015. Investors’ reluctance to accept Google’s moonshot segment strengthened calls to restructure Google. To learn more about some of the challenges facing Google, read A History of Google’s Visionary CEO Sundar Pichai.
The formation of Alphabet
In his 2015 investor letter, Page discussed the company’s many reasons for restructuring. I have deduced that some key reasons included the following:
- Establishing efficient operations across the company.
- Allowing co-founders to explore and fund new avenues.
- Satisfying investors by providing a risk-averse business with assured revenue.
The co-founders arrived at a win-win strategy by adopting an umbrella business model, where a parent company would oversee subsidiaries and handle capital allocations. Alphabet became the parent company, and Google and subsidiaries fell under its umbrella. Subsidiaries were to operate independently and have their own CEOs, and Alphabet would support any subsidiary in distress or in need of capital.
A look at Alphabet’s companies: Google
Google, Alphabet’s biggest subsidiary, was the founding company and the mothership company up until 2015. After the restructuring, Google resumed its search engine and ad businesses. It contributes more than 70% of Alphabet’s revenue. Google includes the namesake search engine and apps YouTube, Google Maps, and Android.
After becoming an independent company under the Alphabet umbrella, Google Fiber curtailed its expansion plans. The company is developing an economical method to provide widespread connectivity. Google Fiber’s CEO is Dinesh Jain.
Nest makes app-controlled smart home devices, including indoor and outdoor cameras, thermostats, and smoke detectors. As its devices can be connected and controlled via the Internet, the company is part of the Internet-of-Things segment. The company, part of Google’s smart speaker division, is headed by Rishi Chandra.
Calico (California Life Company) is a research and development company focusing on longevity, slowing aging, and preventing age-related illness. The company has some of the brightest minds on board, including Arthur Levinson and David Botstein. Levinson, a National Medal of Technology and Innovation winner, is Calico’s CEO. Alphabet also holds Verily Life Sciences, which undertakes end-to-end, non-commercial health-monitoring medical research.
GV (formerly Google Ventures) is a venture capital company headed by entrepreneur Bill Maris. With $4.5 billion under management, it invests in companies across stages and sectors. The company has funded more than 400 companies and has 300 in its active portfolio. GV also scouts for potential acquisitions for holding company Alphabet. Nest is one example.
Google X, now known as X, is a research and development facility directly monitored by Alphabet’s co-founders. Page and Brin created the company to work on moonshot projects such as balloon-powered Internet services (Loon), self-driving cars (Waymo), and drone delivery services (Wing). The segment is headed by Astro Teller, also known as “Captain of Moonshots.”
How Alphabet reports its earnings
As you can see, Alphabet’s businesses are fragmented. One major challenge for Alphabet was determining how to report these diverse businesses’ earnings. If we look at its SEC filings, we can see that Alphabet classifies its businesses in four major categories: Google Properties, Google Network Members’ Properties, Other Revenue, and Other Bets.
Google Properties records revenue from advertisements. The ads generate revenue from Google.com search traffic and Google-owned and operated properties such as Google Maps, Google Play, Gmail, and YouTube. Meanwhile, Google Network Members’ Properties earns revenue from the following:
- AdMob, which allows app developers to promote and monetize their applications via in-app ads.
- AdSense, a service that allows website owners and bloggers to earn money by displaying ads on their web pages, both through page views and number of clicks.
- Google Ad Manager, a platform that helps publishers manage display advertisements on their websites and blogs.
Google’s Other Revenue segment includes money earned from paid-app purchases, in-app purchases, purchases of digital content from Google Play Store, services charged by Google Cloud, and the purchase of Google hardware devices (Pixel, Nest smart home gadgets, and home speakers).
Alphabet’s last segment, Other Bets, is like a warehouse where it develops projects. It mainly comprises sales from Internet and TV services (Google Fiber) and research and development.
Challenges with Alphabet
The biggest challenge for Alphabet and most of its subsidiaries may have been fitting in the frame after restructuring. Earlier, the subsidiary companies were part of the mothership, and their losses would be absorbed by the parent company. However, the new structure made all subsidiaries independent, giving them space to operate freely. As good as the strategy may have sounded, it wasn’t that effective. Only Google and a few other companies managed to generate revenue independently. Most had not achieved growth when they were deemed independent.
Nest is one Other Bets component that struggled after the restructuring. When Google acquired Nest in 2014, it promised generous funding and sufficient time to achieve profitability. But after the restructuring, executives started focusing on revenue, reported Reuters. Operating overheads became pricey, slimming the scope of generating profits.
It’s been half a decade since Google’s restructuring to Alphabet. The holding company has had a bumpy ride, but the last three quarters have been promising. Alphabet’s year-over-year revenue growth of 19% in this year’s second quarter and then 20% in the third quarter indeed tell a positive story. Given the parent company’s earnings progress, it looks like Alphabet now understands its risks and opportunities.
This month, Alphabet saw yet another change of guard, with Sundar Pichai now heading the holding company, Alphabet. The tech giant seems to be in good hands, with Pichai sharing the co-founders’ vision as well as honoring investor sentiment. Moreover, he offers five years’ experience as Google’s CEO.