Google's Big Problem They Don't Want You To Know About

SAN JOSE, CA - FEBRUARY 24: Google co-founder...

Image by Getty Images via @daylife

Since Larry Page took over as Google (GOOG) CEO, he has promised more "velocity" in strategic decisions and more focus.

To my eyes, what he's also brought to the forefront is an marked increase in squishiness of "milestone" numbers he throws out to analysts to explain Google growth.

For several years now, Google has been big on sharing the number of daily "activations" for their Android phones, with no specific definition of what that exactly means. They just keep going straight up is the conclusion Google appears to want us to draw.

Page has also been very aggressive about touting the numbers of Google+ members and engagement since the service launched. Last week, he crowed triumphantly that Google+ had hit 90 million users with 60% engaging daily. Again, the problem is that Larry didn't define his terms. If I'm forced to sign up for + as part of registering for Gmail, YouTube or search, should that count as a registration? And if I then do a search or check my Gmail, should I be counted as engaging with +? It's laughable.

Google is also fond of talking about its annualized revenue numbers for its nascent businesses. For example, from recent calls, we learned that:

- From last week: "Display has now reached an annualized run rate of over $5 billion as we engage with multiple advertisers and get tremendous support from our agency partners."

- From last quarter: "We're also seeing a huge positive revenue impact from Mobile, which has grown 2.5x in the last 12 months to a run rate of over $2.5 billion."

- We of course also have received daily or point-in-time updates on Chrome, enterprise customers, and Android activations.

- We even got an update last week that Google is adding one feature update to Google+ per day last week from Page

Google's top brass are very very smart. Nothing gets dropped into their prepared remarks by chance.

I thought it was interesting when Susan Wojcicki, SVP of Ads, referred in her prior answer in her "script" when answering an analyst's question later. Everything Google says to the public comes from a "script." Nothing is dropped by chance into a comment.

Larry, Patrick Pichette, Nikesh Arora and Susan know that statistics are like pablum for business media and Wall Street analysts. They eat it up and then they regurgitate it like a 12 month old child. They don't question it – because they haven't developed their vocabulary skills yet. They just take it in and throw it back up.

What's more, once one person in the media or on Wall Street repeats that stat, it becomes cited by a 100 other (so-called) journalists or web-scrapers as it bounces around the Internet echo chamber. Who has time to question these numbers? We're just lowly journalists on a deadline for our next story. We're not compensated to actually push back and think. It's just on to the next drive-by report we'll write.

What's more, this is Google – and Larry Page! I'm not going to be the one to say this emperor has no clothes, seems to be the thinking on their part. Nobody ever got fired for buying IBM and no journalist ever got fired for repeated back what number some tech CEO throws out.

But let's pause and take stock of what is going on right now at Google. It has perhaps the best core business that has ever existed in business for at least the last 100 years: its ad business (AdSense/AdWords). That business accounts for 96% of Google's revenues (for a breakdown, see here). From that business, it's stockpiled $44 billion in cash – up $10 billion from a year ago.

With this enviable cash, Google has been able to invest in a lot of new products and businesses, such as YouTube/display, mobile, Docs, Android, and Gmail. Although Google is eager to tell you how well each of those nascent businesses are doing on an annualized basis, they still account for 4% of Google's overall revenues.

The core business — the 96% — is slowing. Google of course will not say this but it inarguably is. The best explanation I have seen of this since last week's call is from Business Insider's Henry Blodget. Among Henry's conclusions:

- Google's core search business slowed more sharply than expected even in the US

- Mobile search, which is accounting for an ever-bigger percentage of overall searches, is less profitable than standard PC-based search – and this is not likely to change

- International's growth in the core business is down to 28% from 41% a year ago

- The growth in the US for the core business was flat at 26% year-over-year

Google tried to blunt this criticism on the call with Pichette (the CFO and attack dog on these analyst calls) saying — in response to a good question from Macquarie's Ben Schachter:

You also have to remember that last year at this time, right, we had such a strong comp. We had such an amazing Q4 of 2010. That the year-over-year comparison in a way represents also this really high kind of level on which to start from. And so from that perspective — and if you also look at our mix between our own Google websites versus all of our network, I mean, our core properties continue to be actually very strong. So for all these reasons, I wouldn't be worried of the way that you've described it. In fact, we've got — continue to have very strong growth.

The other elephant in the room last week was why the sudden drop in CPCs (cost-per-click or basically how much profit Google makes from each click as part of their ad business)? Blodget – I think quite rightly – suggests that it's from more and more people searching Google on mobile where Google doesn't make as much money as they do from PC-based searches.

Not so, claims Wojicicki and others on the call:

So there are definitely multiple factors whenever we look at these metrics because these metrics are aggregate. But I would say the 2 biggest factors this quarter were FX as well as the changes that we had made, their ad quality or format changes, which increased the paid clicks and again were revenue positive, advertiser positive, user positive. But those clicks, as I explained, may be lower CPC like in the example that I gave in my script with sitelinks. So those were the 2 factors. But again, it's always important to remember there are many factors that contributed to these aggregate numbers.

Pichette chimed in:

Yes, I mean, at the highest level and then maybe Susan can jump in if she wants to add additional, if you think of the core elements of it, she mentioned quality. And we — the — all of the Panda changes and everything we talked about, right, its full year is going to be represented only by the next spring. And then FX rate, we don't control ourselves. So obviously, it has a significant impact. The rest of it is actually the mix between how the innovation that we drive to our products, which is if you have a great product that drives a ton of clicks and it happens to have lower cost or CPC, then that's still for the benefit of everybody. So then, that's really about our innovation agenda, but we don't give forward guidance on that.

So, Google's profitability was down because it innovated too much. You got that? Wojcicki took another crack at it:

I mean, the one thing I would just add is, the way we think about the business is we're focused on how do we provide better ads for our users and for our advertisers, and we look at all of those metrics combined. And what we saw in Q3 was we made a bunch of changes. They were small. There was no one individually that actually affected things, but it just so happened that the changes we made drew more attention and caused an increase in paid clicks. And so, as I mentioned, there are many factors. But really, what we use as a guiding metric are to understand that something is revenue, advertiser and user positive.

So Google did some stuff – at the end of Q3 – to purportedly provide better ads and, as a result, advertisers paid less for them in Q4, even though paid clicks were up. Men at work. Nothing to see here. Move along.

But the analysts wouldn't relent and Wojcicki had to try again:

So the 2 biggest factors, as I mentioned, were the FX and also the changes that we made to — in terms of ad quality or format changes that we made. And those were changes that we made in Q3. There was no, I think, one significant one that drove the metrics. Or like this quarter, we made 20 different changes. Last quarter, we made something similar. And it was the combination of those different changes. Now it's important to remember that we rolled those out over the course of Q3. And so that meant that if we rolled one out at the end of Q3, that you wound up seeing that impact in Q4 period. And so there was a cumulative effect. But again, there was not any one big one. It was the sum of a bunch of other changes. And those changes that we wind up making are changes that may make the ads more readable, they may be more visible, they're UI treatments or quality changes. They're a bunch of different things that make it more visible so that users are noticing the ads. And we see those as positive. We measure the metrics, how do our users respond, how do our advertisers respond. And they are revenue positive.

That's some serious gobbledygook.

So, I'm going to try and translate super-smart Google mensa-speak to everyday talk: "Trust us, this stuff is so complex that you wouldn't understand even if I took the time to explain it to you. It would be like a rocket scientist talking shop with a 5 year old."

I loved Pichette's addendum comment next:

Yes. Another way to think about this is in many quarters, we would have a bunch of them that would actually move down the CPC, a bunch of them that would have moved up in [ph] click. It just happens that in the latter part of this year, they kind of all moved one way, which is not neither good nor bad. It just happens that the quality team and the advertising teams actually have kind of unearthed these type of opportunities. So it's a bit of circumstantial as well.

Say what? I know Pichette is a Rhodes Scholar, but me thinks the lady doth protest too much.

At this point, it was getting so confusing that Larry jumped in:

I can take, say, a little bit about CPC from my perspective. I think — and I don't have the detail here, quarter or whatever, but I do think that CPCs — do vary a fair amount, and we're not surprised by that. There are lots of product changes that we can make that can increase CPCs or decrease CPCs and kind of have a — or an inverse effect on the number of clicks and sort of not change the actual dollars spent, for example. And that's not that surprising because we can do things that — in product changes that affect people's attention to ads that Susan mentioned or that affect the quality of the conversions that advertises receive. They might receive better quality clicks, or they're — or those — each CPC that they got that's more likely to convert into what they care about. And so we are constantly optimizing all those things across a number of different product areas and ad placements and everything else. And our advertisers are doing the same, and the algorithms are also doing all that. So I think in any healthy economic — economy, like we have of advertising, we're going to see variation in the different factors we use to measure it. And I'm not surprised by that.

Clear? No?

Pichette finally offered: "It's — that's just the nature of experimentation in our systems." Innovation, again.

This slowing growth in their core business was also obvious last quarter. However, it didn't stick out as much because the profits from the newly-acquired ITA covered it up.

Google bulls like to dismiss the idea that the core business is slowing because they believe Google has so much money that it can just keep buying other companies to get more profits and then finally hit the gusher of new profits from display, social, mobile search, and mobile phones.

However, I think the Google management team's use of language suggests a deliberate effort to conceal just how big the slowdown in their 96% core business is.

[no position]