How Google does it

The secret behind the success of tech's great innovator.

By the time What Would Google Do? hit bookstore shelves earlier this year, a clear theme was beginning to emerge. In just the past 12 months, a succession of titles like Planet Google, Google Speaks and Inside Larry and Sergey’s Brain have promised to reveal the secrets behind the company’s tremendous success. And like all of the others, What Would Google Do?, with it’s messianic undertones, zeroes in on the company’s astounding ability to generate revolutionary ideas. “Google’s lesson is clear,” writes author Jeff Jarvis in his advice to car companies, restaurants, universities, charities and even governments. “Make innovation your business.”

From its modest start as a search-engine research project at Stanford University in the mid-1990s, the Google universe has expanded exponentially with new products and services. It’s already a word processor, e-mail service, smartphone, and aims to be a storehouse of every printed word in human history. Google allows us to cruise the streets of New York and Rome, or scour the surfaces of the moon and Mars. We can track global flu trends, monitor our household energy usage or simply edit photos. And thanks to one of its latest debuts, Google Voice, we can now carry around just one phone number with us for the rest of our lives (in the U.S. at least, for now). The pace with which Google has leapt into these wildly divergent fields has been truly astonishing, and it’s left many people, from academics and politicians to investors and countless senior executives at other firms, trying to replicate the company’s innovation model.

But while Google enjoys an almost unmatched reputation for invention and discovery, look closer and another picture emerges. Many of the services that have generated the biggest buzz among users in recent years, and helped drive the company’s stock market value to such phenomenal heights, didn’t originate from its engineers’ brains, but from its gigantic bank account. “There’s this image out there of Google being an unparalleled innovator, but when you look at their products and services, most of their innovation has taken the form of refinements to other peoples’ ideas,” says Nicholas Carr, author of The Big Switch: Rewiring the World from Edison to Google. “Once you go beyond their basic search engine, a whole lot of the Google products we’re familiar with came into the company through acquisitions rather than internal development.”

That basic misunderstanding is important because Google is well on its way to becoming perhaps the most influential corporation on earth — reshaping entire industries and changing the way people think about company management. And the popular image of Google as a hotbed of engineering genius and dynamic thinking stands in stark contrast to its record as a voracious acquirer of small firms and nascent technology. Only by coming to grips with the way that Google has actually built its business is it possible to understand what really makes the company tick — and why its legions of observers and admirers so often get it wrong.

The real secret to Google’s mystique is that of a company that understands the possibilities of technological change, and where to look for the small companies with big ideas that will change established business models. And in that way, it is following in the time-worn footsteps of other acquisitive giants like Cisco Systems and Microsoft. Like any other giant multinational, Google knows that if it doesn’t constantly add new products and services to its business, its days are numbered.

Perhaps that was somewhere in the back of CEO Eric Schmidt’s mind a few weeks ago, as world leaders gathered in Pittsburgh for the G20 summit. During a talk at a side conference, he delivered a simple message to shareholders. Like all businesses, Google had hunkered down during the worst months of the recession, mothballing some lesser-used services and halting acquisitions. But with its shares at nearly US$500, almost double their November lows, and US$11.9 billion in ready spending money, Google has already brushed off its chequebook. “Acquisitions are back on” at Google, Schmidt said. The company just received regulatory approval to buy On2, a maker of video compression technology, and has signed another deal to buy ReCaptcha, which provides an anti-spam and optical recognition service. Over the next year, Schmidt said, Google expects to do at least one deal every month.

That is a blistering pace, but many of those acquisitions only make headlines once Google has brought some flashy new service to market. Take, for example, the uproar surrounding the March launch of Google Voice. With the service, users will be able to receive calls on their work, home and cellphones — as many as six different lines — through one number via the Internet. It comes with free long distance, free voice mail, and can even transcribe voice mails into text. The backlash from rivals in the telecom industry has been swift. Google accused Apple of blocking the application from the iPhone, while AT&T has filed a complaint with U.S. regulators. But while Google has been hailed for revolutionizing the staid telco industry, the technology was originally launched in 2005 by a company called Grand Central. Two years later, Google acquired the start-up for an estimated US$45 million.

In many ways, it was a perfect example of what Google looks for in its acquisition deals. According to Sean Dempsey, who worked in Google’s corporate development department from 2005 to 2007, a time of rampant deal-making, Google’s takeovers typically follow a pattern. “The acquisitions tend to involve smaller companies, smaller teams, with really innovative people and technology,” says Dempsey, now a managing director with Merus Capital, a Palo Alto, Calif., venture capital firm. Sometimes acquisitions are used to fill gaps in Google’s existing line of services, but more commonly, he says, the deals are opportunistic in nature. That appears to be the case with the purchase of Grand Central. It was a company with just a handful of very bright employees, and Google gained control of a cutting-edge product. “When Eric Schmidt talks about picking up the deal pace, that’s what he’s talking about,” says Dempsey.

For anyone who watches the company closely, the pattern has played out over and over again. For example, everyone now knows Google for it’s handy online mapping tools. In 2004, Google bought Where 2 Technologies and Keyhole, giving it the foundation for Google Maps and Google Earth. The company has since pushed the limits with features like Street View, which will see a fleet of cars equipped with special 360-degree cameras photograph every street in the world. And the company is rightly proud of how it builds on the technology it acquires. “There’s no shortage of home-grown innovation at Google but, at the same time, this has often been a place where acquired technology is brought to the next level thanks to the scope and scale of resources available here,” wrote Google spokesman Matt Furman in an e-mail. Still, the reality is the technology was conceived beyond Google’s walls.

It was a similar situation with Google Docs, which grew out of three separate acquisitions. The suite of office tools lets users write, edit and store documents through their web browsers, with the files stored on Google’s servers. Though Google Docs has yet to put a serious dent in the dominance of Microsoft Office (which still controls 95% of the market), it’s gaining ground. According to a recent survey conducted by research firm IDC, one-fifth of companies use Docs in their organization, up from 6% a year ago. In the case of Google Docs, Dempsey says Schmidt felt the company needed to make an authoring tool available to its users. But of course, someone else had already done that, so Google opted to snap up the team rather than try to build an online word processor from scratch. Surprisingly, Jen Mazzon, part of the team at Upstartle, one of the acquired companies, was worried about what she could bring to the Google innovation machine. “What could our little team possibly do that’s innovative enough?” she fretted in a blog post. Her husband had the right answer. “Hello? You already did it!” More to the point, Google didn’t.

There’s no question the initial spark that spawned Google was the stuff of genius, and revolutionized how we interact with the Internet. While at Stanford, Sergey Brin and Larry Page developed powerful search algorithms that sifted through the mash of websites and brought to the top those that had the most relevant information, based on the quality and number of other pages linking to them. It was Web search as popularity contest, and before long Google was quickly gaining fans of its own. With the addition of its Gmail electronic mail service, another in-house innovation, the company suddenly had incredible access to what its users were searching for and talking about. Once it began selling ads that targeted and exploited this information, arguably Google’s most lucrative brainwave yet, its growth exploded. Last year, Google generated US$4.2 billion in profits on US$21.7 billion in revenue. The company’s market capitalization recently hit US$158 billion, greater than the entire economic output of Canada’s nine smallest provinces and territories combined.

If Google’s most inventive discoveries were also its earliest, the company has worked hard to maintain its image as the world’s greatest idea factory. It’s a perception the company has carefully crafted, from its founding mission statement, “to organize the world’s information,” to things like its offer of a US$30-million prize in a private lunar expedition competition. In fact, stories of freewheeling ingenuity at its Mountain View, Calif., headquarters, known as the Googleplex, are the stuff of legend. Employees are given a day every week to brainstorm their own ideas, called innovation time off. The company has adopted a rule that dictates at least 10% of its energy and resources must be devoted to completely new undertakings. And worried that even in such an encouraging environment some groundbreaking initiatives are being trampled under foot, the company recently launched “innovation reviews,” according to news reports, where managers present their underlings’ brightest ideas directly to Page and Brin, as well as CEO Schmidt.

No wonder Google regularly appears at, or near, the top of annual innovation rankings. Well, except for this year, when the business magazine Fast Company gave the “most innovative” honour to President Barack Obama’s election campaign team. Perhaps that shouldn’t come as a surprise, though. When then-senator Obama visited Google in late 2007, he said his country must follow Google’s lead. “Technology and innovation have reshaped our economy and our lives at breathtaking speed,” he told the crowd of geeks and engineers who were, arguably, more responsible than almost anyone on the planet for much of the shakeup. “America’s been fighting to figure out how to tap this awesome new resource that we have, and Google has helped to show us the way.” With America experiencing a crisis of confidence as the cornerstones of its manufacturing economy fall away, many see Google as a beacon for success in the knowledge economy.

Yet Google’s acquisitive nature suggests it’s actually a lot more like that other American tech giant, Microsoft, than a new breed of company. Any such suggestion is sure to generate howls of laughter from adoring tech bloggers and Google’s most fervent admirers. In the eyes of many, Microsoft has fallen embarrassingly behind Google in the Internet wars, and uses acquisitions in a desperate attempt to play catch-up up with Google. They point to last year’s attempt by Microsoft to buy Yahoo Inc. in a US$44.6-billion hostile takeover. (In July the two companies agreed to a search and online advertising partnership.)

But the closer you look at the two companies, the more alike they seem, especially when it comes to finding and acquiring complementary technology. While powerhouse products like Microsoft Word and Excel were developed in-house, many other tools and services came from outside the company. In 1987, Microsoft bought a small company called Forethought for $14 million, snagging its PowerPoint presentation software in the process. And in 1997, it bought Hotmail, which to this day remains one of the largest web-based e-mail services. “They’re really similar companies,” says Dempsey, who before joining Google worked in Microsoft’s corporate development department. “They’re both software companies. The software DNA is the same for both. And both favour smaller deals. Microsoft has just been an acquirer of companies for a longer period of time.”

More important, both companies have faced the same problem any large multinational tech company eventually does. After making their name through an initial product or service, they struggle to repeat the success and maintain growth. Without a constant stream of new products and services to lure customers, eventually another competitor will come along and replicate their business model more cheaply. “Lightning doesn’t strike twice very often,” says Carr. “As companies get bigger and more bureaucratic, they have to build up by going out and buying other people who are doing original work.”

This is even truer for Google, because while Microsoft collects sales and licensing revenue for its products, Google’s business model relies overwhelmingly on selling ads around its services. Despite its foray into so many different sectors, a whopping 97% of Google’s revenues still come from web- and search-related ads. And for all the takeover deals it’s done, Google has yet to come up with an alternative revenue stream. Three years after buying YouTube for US$1.65 billion, the only way it has found to earn revenue from all those videos of pirated Miley Cyrus concerts, ranting bloggers and cute kittens is more ads.

The situation has led some analysts to begin thinking of Google not as a cutting-edge technology company, but an advertising company that’s looking long in the tooth. “The vast majority of the revenues Google generates today is still based on the idea that was conceived by Larry and Sergey in 1998,” says Trip Chowdhry, an analyst with Global Equities Research. “More than 10 years later, that’s still their only cash cow.”

Not surprisingly, the company is determined to battle this growing perception. In an interview in April, Google CFO Patrick Pichette insisted the company is about a lot more than ads. “I think that Google is actually not an advertising company,” said the former Bell Canada senior executive, who joined Google last year. “Google is an innovation company, in which it happens to have a core business today that relies on advertising for its revenues.”

To drive home the point, Pichette highlighted several of Google’s newest services, including Android, an operating system for wireless devices. “Google is lucky [because] it has the power in terms of resources in engineering and resources in general, to be at the forefront of these really profound changes that are going to change society in the coming decade.” But while Android is clearly an innovative product — many analysts see the open-source operating system as a serious threat to Apple and Research In Motion’s dominance of the smartphone market — the fact is, the technology behind Android came about because Google pulled out its chequebook. In 2005, it bought Android Inc. and its small team of developers for an undisclosed sum. What they lacked was Google’s reach, and its marketing savvy.

With Google set to embark on another round of acquisitions, there’s no telling into which new directions it will expand. Chances are, when the deals do come to light, analysts and observers will be left scratching their heads. When Google bought Android, it touched off years of speculation about what the company was up to. Other deals might lead to new services that briefly flicker to life before fading away — the purchase of ZipDash in 2004 lead to Google Ride Finder, a tool that helped users find the nearest taxi. But the service drove off into the sunset earlier this year. And many more acquired companies will simply disappear into the Googleplex, never to be heard from again. But what is certain is that the world’s fascination with Google, and its apparent ability to dream up fantastic new ideas, will only grow stronger. If nothing else, this next batch of acquisitions should at least guarantee that.