INTERNET

Why Google Became Alphabetby Todd Zenger

AUGUST 11, 2015

The company that yesterday was known as

Google is now a collection of separate

companies, owned by a new holding company

called Alphabet. The “Google” brand is the

largest of those companies, and it includes

search, advertising, maps, apps, YouTube,

and Android. The company’s less related

endeavors – the biotech research project

Calico, the Nest thermostat, the fiber internet

service, the “moonshot” X lab, Google

Ventures, and Google Capital — are all now

separate companies housed under Alphabet.

Why? And will it work?

The Google founders are already being called

Warren Buffetts-in-training. But as always,

the company defies easy comparison. Google

is not becoming Berkshire Hathaway, at least not exactly. It’s trying out something else

entirely. Largely in an attempt to placate investors while preserving the founders’ unique

theory of what their company is.

The restructuring is clearly a response to Google’s stagnant share price and investor unease.

My argument has long been that Google’s current theory of value creation is essentially to

funnel its vast profits from the search and advertising business into the hiring of strong

talent, and then to give employees wide latitude to explore and pursue whatever they wish.

This is embodied not only in the pattern of rather unrelated investments and acquisitions,

but in policies about hiring, salaries, and 20% free time.

Investors have been uneasy about this strategy, but Larry Page and Sergey Brin have also

composed a corporate governance regime that insulated them from much shareholder

pressure for change. Eventually, with growth in search advertising slowing, investors’

dissatisfaction manifested itself in a stagnant stock price. And in recent months the

company has taken steps to rein in some of its investments, slowing growth in expenses,

and also tightening the reins on the 20% free time policy. These were the beginnings of a

shifting direction at Google.

Analysts had their own problem with Google’s structure: its bundle of businesses was

extremely difficult for them to evaluate. The primary challenge for analysts has been that

the performance of the main business was not transparent—the financial returns of the

search engine and advertising business could not be observed separately from the

investments in all of the new businesses. The new structure ensures that there will be, at a

minimum, independent accounting numbers produced for the Google business, and

perhaps for the others as well.

Investors will inevitably push for more. The market’s response has so far been positive, with

the stock price up 6%. And I suspect it will also have a longer-term performance impact, as

greater transparency of both its cash flows and investments prompts greater discipline and

Why Google Became Alphabet

accountability. But I doubt this move will fully pacify the uneasy investor. While this new

organizational form increases transparency, that transparency only further illuminates the

disconnect between Alphabet’s various businesses. It simply highlights the question of why

the various businesses are bundled together. Investors are still buying the whole collection

of projects, only now they’ll be able to see clearly just how much search advertising is

subsidizing the rest.

As for the comparison to Berkshire Hathaway, there are some parallels. Berkshire Hathaway

is a publicly traded company that is run like a private equity firm. It, like Alphabet, is a

portfolio of very unrelated businesses. However, the important distinction is that Berkshire

Hathaway’s businesses are generally cash producers and Berkshire’s task is to improve on

the cash they already generate. Alphabet will be more like a cash cow coupled to a venture

capital firm, investing in early stage and in some cases highly capital-intensive new

ventures.

Berkshire Hathaway has assembled a group of investors who are confident in its theory of

value creation. That’s the challenge that Google-as-Alphabet still faces. Who wants to

simultaneously invest in a search engine, longevity research, thermostats, and drones? The

new structure will make that investment proposition more transparent, but the company

still needs to convince investors, as Berkshire has, that their theory of value creation makes

sense.

Todd Zenger is the N. Eldon Tanner Professor of Strategy and Strategic Leadership at

University of Utah’s Eccles School of Business.

Related Topics: STRATEGY

This article is about INTERNET

FOLLOW THIS TOPIC

Comments

Leave a Comment

P O S T

REPLY 0 0

9 COMMENTS

Shafiq Hamid 10 hours ago

The Alphabet approach is not the right way forward for Google. My thoughts here:

https://www.linkedin.com/pulse/googles-alphabet-may-spell-trouble-shafiq-hamid?trk=pulse_spock-

articles

POSTING GUIDELINES

We hope the conversations that take place on HBR.org will be energetic, constructive, and thought-provoking. To comment, readers must

sign in or register. And to ensure the quality of the discussion, our moderating team will review all comments and may edit them for clarity,

length, and relevance. Comments that are overly promotional, mean-spirited, or off-topic may be deleted per the moderators' judgment. All

postings become the property of Harvard Business Publishing.

JOIN THE CONVERSATION