Google Inc. in 2006 Can the Strategy Support the Lofty Stock Price? Overview In 2005, Internet searches were the second most common online activity after e-mail. Advertisers spent an estimated $12 billion on paid search Internet ads in 2005375% more than spending for such ads in 2004. Advertisers believed search-based ads were particularly effective because they were highly targeted to what Internet users were immediately searching for. In 2005, Google was the leading search engine on the Web and provider of search-based ads because of Internet users' faith in the search engine. The company did not collect information on search users, placed ads discreetly on its page listing search results, and did not intersperse paid search results with non-paid search results. Perhaps Google's most important feature was its capability to retrieve highly relevant results to search queries that was made possible by its innovative PageRank technology. Internet users' preference for Google's search results allowed the company to establish hundreds of thousands of accounts with advertisers, which had produced 2004 revenues of nearly $3.2 billion and profits of more than $399 million. The company executed a successful initial public offering (IPO) in August 2004 that brought in an investment of $1.7 billion and made a subsequent offering in September 2005 that added nearly $4.3 billion to its coffers. The company's cash and cash equivalents stood at $5.5 billion at the end of its third quarter of fiscal 2005. At year-end 2005. Google seemed poised to repeat its stellar 217% growth rate in revenues and 377% growth rate in net income between 2003 and 2004, since its revenues and net income for the first nine months of the fiscal year stood at $4.2 billion and $1.1 million, respectively. Google's highly scalable business model delivered profits for the nine-month period of more than $500,000 per employee. Google's stock price had risen from its $85 IPO price in August 2004 to over $443 at year-end 2005. In late-December 2005, the shares traded at a price/earnings multiple of 95-pushing its market capitalization over $131 billion. In comparison, the market capitalization for General Motors was $12 billion, the market value of Chevron's shares was $129 billion, and Intel's market cap was $159 billion. Some analysts still saw Google as a "strong buy" since as much as 30% of consumers' exposure to media was through the Internet and, as of 2005, only a small fraction of the $300 - $400 billion spent on advertising in the U.S. was allocated to Internet ads. Others considered Google's stock to be highly overvalued-pointing to a business model that relied almost exclusively on revenue from search-based ads. Over time, such ads might prove to be less effective than other forms of advertising or might reach more Internet users if provided by a rival search engine. Clearly, web portals such as Yahoo and MSN were working furiously to improve search functionality to lure Google's loyal users to their sites. Yahoo had developed its own search capabilities in 2003 and severed its three year agreement with Google to provide search results and ads for the web portal in July 2004. Microsoft had spent more than $150 million and taken 18 months to build a search engine in an effort to match Google feature for feature. MSN Search was launched in winter 2005 and provided direct links to MSN Encarta and other sites for searches written in plain- language. In addition, MSN search users could search image files, music files, news stories, e-mails, files residing on their PCs, narrow search results locally, and pull up satellite-based street maps for almost any part of the world. Perhaps the biggest threat Microsoft posed to Google's dominance in search was its ability to embed MSN Search into Outlook, Internet Explorer, and Office applications. In fact, Microsoft had a long track record of exploiting Windows integration to upset incumbents as the market leader. During the late-1980s and early-1990s, Excel surpassed Lotus 1-2-3 as the market leader in spreadsheets within four years of its launch. Lotus held a 70% market share prior to Excel's development. Similarly. Word beat out WordPerfect as the dominant word processing program and Netscape proved to be no match for Microsoft in the war for market share in the browser category. Also of concern to some analysts was the mysterious nature of Google's cash reserves. International expansion and the development of new features such as Voice over Internet Protocol (VoIP) telephone service were obvious strategic initiatives Google should pursue, but the company had made no comments regarding the specific use of its $5.5 billion cash balance. The company also held $2.1 billion in marketable securities at the end of its third quarter of 2005. Google's management itself seemed uncertain what might drive future growth. The company's two founders, Sergey Brin and Larry Page, wrote in the company's IPO prospectus that "We would fund products that have a 10% chance of earning a billion dollars over the long term. Don't be surprised if we place smaller bets in areas that seem very speculative or even strange. The company's cash reserves had spawned hoards of Mountain View, California entrepreneurs with the end goal of being acquired by Google, However, as of late 2005, Google had been a tough sell for those making pitches, having completed only five modestly-sized acquisitions. The company's expanded advertising partnership with AOL announced in December 2005 that involved Google acquiring a 5% stake in AOL for $1 billion was by far its most ambitious financial investment. Suggestions for Using the Case Students will likely look forward to discussing Google Inc.-Can the Strategy Support the Lofty Stock Price because of their frequent use of Google and other search engines. Also, Google is a high-profile company, one that is regularly in the business headlines when it makes new strategic moves or reports its latest financial performance. It is clearly one of the most important and influential companies of the early 21" century. We think the case is best positioned in the middle or second half of your module on business strategy The case analysis calls for students to wrestle with an assessment of the five competitive forces, industry driving forces and industry key success factors. There's also an opportunity for you to have students evaluate Google's business model and competitive strategy along with specific elements of its strategy. So far, Google's strategy and business model have generated outstanding financial performance (the case contains financial data back to 1999), but there are all kinds of questions about how the company can sustain its rapid growth and maintain such a high stock price (in terms of its price-earnings multiple). Students should be expected to examine the company's rapid growth in revenues and profits, assess the long-term value of its business model, and evaluate relationships in its financial statements. Students also must consider possible uses for Google's sizable liquid financial resources and strategies needed to sustain its impressive growth rate. They will also learn about Google's novel its Dutch Auction in going public and issuing its first shares of common stock to the public. There is a video accompanying the Google case, which we suggest showing at the beginning of class. It will help set the stage for the class discussion. The Google case is ideal for drilling the class in doing SWOT analysis-students really need to have a strong grasp of Google's key resource strengths and competitive capabilities and its weaknesses, opportunities, and threats before attempting to make strategic recommendations. Because of the number-crunching possibilities and the emerging threats to Google's competitive advantage, the case is an excellent choice for oral team presentations or a written case assignment. Our suggested assignment questions are: Google's top managers have heard of your budding skills of analysis as a new project manager with the company. You have been assigned to a strategic planning committee where your charge is to analyze the search engine industry and Google's competitive position. Your report should include a 2-3 page executive summary of recommendations necessary to allow Google to defend against threats and strengthen its lead in the industry. Your recommendations should be specific and supported with facts from your industry analysis, company situation analysis, and financial analysis. Please attach whatever tables, figures, or other exhibits you believe necessary to support your conclusions. (You should utilize the financial ratios presented in Table 1 of Chapter 4 as a guide in doing your financial analysis of the company.) Please prepare a 5-6 page report that analyzes the search engine industry and Google's competitive position in the industry. Your report should include a Five Forces analysis, list of industry driving forces and key success factors, a SWOT analysis and financial analysis for Google's performance between 1999 and the first nine months of 2005. Also, please recommend strategies necessary to allow Google to defend against threats and strengthen its lead in the industry. Your recommendations should be specific and supported with facts from your analysis. (You should utilize the financial ratios presented in Table 1 of Chapter 4 as a guide in doing your financial analysis of the company.) Assignment Questions 1. Discuss competition in the search engine industry. Which of the five competitive forces seem strongest? weakest? What is your assessment of overall industry attractiveness? 2. How is the search engine industry changing? What forces seem most likely to bring about major change to the industry within the next three to five years? 3. What are the key factors that define success in the industry? What are the key competencies, capabilities, and resources of successful search engine companies