Google and Amazon: Doing It All Wrong

by Steve Wildstrom   |   March 13th, 2013

Google Glasses (Google)

 

 

By the conventional standards of business, it would be hard to find two companies with a greater tendency to do things wrong than Google and Amazon. Yet both are regarded as outstanding success story. What is going on here, and what does it tell us about how corporations ought to be run.

Each company violates a fundamental rule of business. In the case of Google, it’s a failure to diversify its sources of revenue and profits while at the same time displaying a woeful lack of discipline in how it enters new businesses. For Amazon it’s a persistent, almost stubborn refusal to maximize profits.

A glimpse at Google’s income statement reveals just how narrow the company’s success is. Google took in $50.2 billion in the year ended Dec. 31. Of that revenue, $31 billion came from advertising on Google Web sites and another $12.5 billion from ads on Google Network affiliate sites. This means that Google’s original revenue-producing activities, AdWords and AdSense, accounted for 87% of its gross. Motorola brought in another $4.1 billion Everything else–the Google Play Android store, sales of Google Nexus branded Android devices, paid Google Apps, whatever else the company does to produce revenue–generated a mere $2.4 billion. Considering that Motorola suffered a heft net loss from continuing operations, it’s safe to say that search-based advertising was responsible for well over 100% of Google’s revenues.

The unprofitability of everything Google has tried does not seem to discourage the company. Under CEO Larry Page, Google has purged a number of its least successful products. But it continues to add efforts that have little hope of generating profit in the near-term, or perhaps ever. It is spending a good bit of money developing self-driving cars, though the technology seems years away from commercialization. It’s from from clear that many people away from such hotbeds of geekdom as the Googleplex or the MIT campus will ever be willing to wear, let along pay for, Google Glasses (above.) Who but a Google engineer is going to put down $1,299 for a Chromebook Pixel, a laptop that cannot run any programs other than a Chrome browser? And why is it messing around with same-day-delivery retail, a business that seems far outside its core competency–and a logistical and business challenge that no one has cracked?

Classical economic theory says corporations try to maximize profits. Amazon and Google prove there are exceptions.

Of course, the ad business is so profitable that Google doesn’t have to worry in the near term. It’s net margin was 21%, down from recent years but still very healthy. And investors seem happy. It’s stock is trading just a bit below its 52-week high of 844 and the price is 26 times 12-month trailing earnings, a sign that investors believe growth will be healthy into the future.

So while Google’s attention deficit approach to new projects may defy business school wisdom, it isn’t hurting the company. And it is certainly benefiting consumers. We get goodies like Google Maps and Gmail for free, while Google funds the sort of research–self-driving cars–that once was the province of the government and that could have a big payoff for society, if not for Google.

If Google’s problem is a flurry of innovation that has produced little revenue and no profit, Amazon is a tale of profitless growth. Classical economic theory says the purpose of a corporation is to maximize profits, and while the research of scholars like A.A. Berle and and Herbert Simon long ago dismissed taking that notion too literally, profit motivation is still supposed to have something to do with business decisions.

Not, it would seem, at Amazon. The company’s revenues in the fourth quarter of 2012 grew 21%, and that was the worst performance in three and a half years. But profits are another story. In its best year, 2010, it netted just over 4% of sales while it actually recorded a loss last year. Amazon has relentlessly pursued growth with little regard to profitability. It has disrupted one market after another by undercutting the prices and business models of competitors.

And its investors love it. Like Google, it is trading near a 52-week high. Its trailing EPS can’t be calculated because of the loss, but Amazon is trading at a staggering 76 times expected 2013 earnings.

And  customers love it too. Unless you are in a retail business that Amazon has demolished, you are most likely the beneficiary of Amazon’s predatory nature. Amazon has not only saved me money, it has saved me countless hours I would have wasted shopping. (Once you get Amazon Prime, the tendency to order stuff online rather than pick it up at the store become overwhelming. It’s a rare day we don’t get at least one Amazon package.) And while Amazon’s impact on retailing has been the most obvious, Amazon Web Services has drastically lowered the cost of starting any sort of online business.

So let’s hear it for Amazon and Google and their impossible business models. Eventually, Google will to find a moneymaking business to supplement search ads, whose growth is slowing. And Amazon investors’ patience with tiny or nonexistent profits won’t last forever. But for the rest of us, let’s enjoy it while we can.

 

 

Steve Wildstrom

Steve Wildstrom is veteran technology reporter, writer, and analyst based in the Washington, D.C. area. He created and wrote BusinessWeek’s Technology & You column for 15 years. Since leaving BusinessWeek in the fall of 2009, he has written his own blog, Wildstrom on Tech and has contributed to corporate blogs, including those of Cisco and AMD and also consults for major technology companies.
  • http://twitter.com/greengart Avi Greengart

    Steve, Good stuff, but I’m hoping you follow up with a companion article where you fully answer the second half of your opening question: what does it tell us about how corporations ought to be run? And what advice do you have for those who compete with companies that are doing it all wrong?

    • steve_wildstrom

      That everyone should do it so wrong?

      One advantage that both Amazon and Google do have is that should investors sour on them, it might be a bummer for option holders, but a drop in the stock price would not affect anything substantive. Both are generating plenty of cash from operations and neither seems inclined to use its stock for major acquisitions. (This is, of course, also true of Apple.)

      Not all companies have that luxury.

    • gdavid2

      Conning investors to believe the company they have invested in will make money someday is nothing new. The bankruptcy courts see them on a daily basis.

  • def4

    Once you get past the conventional wisdom, it’s not hard to understand Google and Amazon.
    It’s important not to try to understand the companies because they are after all made up entities. What really matter are the motivations and objectives of the people that control them.

    Both Google and Amazon are controlled by very few people with very similar views and that is what makes them special.
    The conventional wisdom applies to many public corporations because control is so diffused that the only thing that everyone in control has in common is good old fashioned greed.

    • stevesup

      The only traits that Google leaders seem to share, publicly, are hypocrisy and narcissism. And greed. That Jeff Bezos. He’s plenty smart.

      • def4

        That’s interesting, I find it quite the opposite.

        Jeff Bezos seems quite narcissistic and greedy for power, not money.
        The Google guys seem very smart and quite convinced of their positive impact even though their flawed moral compass and fears lead them to some unfortunate reactions.

      • Rich

        Bezos is smart? More like totally brilliant.

        • stevesup

          I did say plenty smart.

  • fran farrell

    Developing peripheral awareness of threats and opportunities and presenting them JIT to human ancestors was the competition that lead to your physique and behavior. If I had one business to be in, I’d choose search (for the sake of my progeny).

  • Rich

    “Investors love Amazon. It is trading at a staggering 76 times expected 2013 earnings.”

    “Amazon investors’ patience with tiny or nonexistent profits won’t last forever.”

    I don’t know…if investors love Amazon trading at 76 times earnings, I’m not sure why they would become impatient.

  • Rich

    Google has said they’re not afraid of failure. Actually I believe they said not trying new things is a greater risk than trying and failing. I really think Google is a good example of intellectualism taken to an extreme point, and their money allows them to do that.

    Why is Google messing around with same-day-delivery retail? They’re so data-driven, they probably generated some data that told them it was a good idea. They’ll try it out, it will go nowhere, and they’ll shrug and move on to something else. Then again, self-driving cars are just beautiful, and they *are* coming. I think they’ll be the biggest improvement since the automobile was invented. You don’t have to be a geek to see that computers can be way better drivers than people are.

    • http://twitter.com/qka qka

      Also, I can’t help but thinking that from all the data that Google is collecting about everything, some of it will be important in the self driving car business, and Google will stand to profit nicely from that.

  • Kyrke

    It seems part of Amazon’s practice is to disrupt commerce in such a way that they eventually can raise prices to make their long awaited profits. One can see or at least hope that significant profits will come. Google, on the other hand, is making their big profits now. What will investors do if they wake up and realize Google has squandered the investors’ monies on give-a-ways and business failures? Money has been thrown into interesting but costly business failures. Money that really belongs to investors.

    TP has previously covered potential threats to the search-ads business Google has thrived on. If a change does come they could end up scrambling as we see Microsoft doing, a significant player working hard but not really getting any traction outside of their core business. I like Google and Amazon but am very frustrated by press accolades of their business practices that need refocus.

    • steve_wildstrom

      I have been hearing for more than a decade now that Amazon is engaged in what amounts to predatory pricing: Using its market power to drive down prices now in the hopes of cornering the market and raising prices later. It seems like a reasonable theory, except that it never seems to happen.

      Amazon did push up book prices, but only when forced to by publishers in what they have more or less admitted was illegal collusion with Apple (the civil antitrust case against Apple is pending; the publishers have all settled.) Now those prices are drifting downward again.

      So this may all be a great plot by Amazon, but if so, it is a very long game.