Is Google’s restructuring a sign that the company is the new conglomerate? Or a venture fund? Neither of it. The restructuring is just a manifestation of a larger trend and it includes such giants as Amazon and Facebook.
There has been a lot of talk about Google’s recent surprise reorganization and rebranding of its holding company to Alphabet. On the one side, their mature advertising and internet businesses such as Google, YouTube and Google Maps will still run under the Google brand. On the other side, the younger portfolio companies such as Nest, Calico, Fiber, Google Ventures, and Google X will be independent from the ‘grown up’ Google. Both of these groups makes up the Alphabet. Although surprising in some way, this was a logical decision by Google’s leadership.
Google as a ‘grown up’
Media and tech reporters, as well as analysts all over the web, are discussing the reasons behind Google’s restructuring. After reading 20 articles, some with more and some with fewer insights, most of the ideas boil down into two reasons for the reorganization:
1. The Investor Sphere
The first reason is based on the interests of investors. The reorganization will enable Google to increase transparency within its diverse businesses. While the core business is profitable and rather mature, the remaining part of the business includes activities, which have a venture character, like the example of self-driving cars illustrates. The reorganization makes it easier for Google’s investors to assess each of them independently.
2. The Business Operations
The second reason is that the reorganization will make each of the businesses easier to lead. The various types of business require different kinds of management, different organization forms, and different corporate cultures. Incentives and accountability add to this logic. The independence of subsidiaries helps recruit and motivate talented managers. Finally, independent reporting makes it easier to measure performance.
Google’s reorganization into Alphabet might not come as too much of a surprise. Many companies go through this kind of reorganization; this is part of the growing up of a company. This doesn’t mean that Google’s offices will go from Silicon Valley campus-style to the gray cubicle-style of Wall Street. However, it means that Google’s organizational structure will change to reflect the different levels of maturity of its businesses.
When I was a kid, I loved being at the children’s table. Us kids weren’t really interested in the topics that the adults talked about. They were not relevant for the phase that we were in. Today I don’t sit at the kids table anymore. The same goes for companies that have different ages. They face different challenges that they need to talk about.
Berkshire Hathaway 2.0
The first news-cycle around this reorganization has often compared Google’s new structure to Berkshire Hathaway. True. From an organizational Google (Alphabet) has become a holding company. The subsidiaries are managed independently, and the Google founder’s roles resemble Warren Buffet’s role, steering the holding company, while leaving the day-to-day operations to various management teams. Larry Page will not be supervising product development or marketing activities. Instead, he allocates capital across portfolio companies and help set their course.
And yet, the parallels between Alphabet and Berkshire Hathaway stop here.
Let’s leave this organizational point of view and compare the Berkshire subsidiaries with the Google businesses in an operational sense. You don’t even have to look into the companies to see that there is a difference. Just the names tell a vivid story. On the side of Berkshire Hathaway, you have Acme Brick Company, Applied Underwriters, Buffalo News, Fruit of the Loom, Geico car insurance, and some other insurance businesses. On the other side you have Fiber, Google X, Nest Labs and Calico. As we all can see, while the first group could be pictured moving at the speed of a chess game, the Alphabet group of companies can be imagined with the energy level of a boxing match.
In fact, they are portfolio companies that are different from one another; operating at different speeds and in different markets. They require different types of management, different cultures, and different structures. But most importantly the younger Alphabet companies also have a very different risk profile, not only distinguishing them from Berkshire Hathaway, but also from the mature Google companies.
With that risk profile, the younger Alphabet portfolio companies require a different type of assessment. Clearly, an investment in self-driving cars needs a different assessment than an investment in a market-leading search engine.
Investors may ask, “Why is this company turning into a venture fund? Why don’t they leave this to the Sequoia’s and A16z’s of this world?”
That’s a fair question. Why should the company do the capital allocation, when the investor can do it more efficiently?
This is also the reason why conglomerates are not terribly in favor. They are regarded as a leftover from the 1960’s. More often than not their strategies did not work out very well. Companies such as Facebook and Amazon have been criticized for turning into conglomerates. Is Google on the wrong track?
Well, part of Alphabet’s activities may indeed be driven by Google’s founders interest to pursue new endeavors and to reallocate capital.
On the other side, we can see a pattern here. It’s not only Google that invests heavily in new ventures. Two other huge examples are Amazon and Facebook. Amazon is basically a mix of several business. And each dollar of profit that a mature Amazon business generates will be reinvested in a new business. Facebook’s hasn’t been too lazy either. They have been purchasing more mature but high-growth, high-price, high-risk businesses. One of their recent acquisitions was WhatsApp for which they paid an equity value of $ 19 bn. At the time, many observers didn’t understand rationale for the price that Facebook has paid for WhatsApp.
The pattern continues with the corporate incubators, accelerators and venture funds, that are chasing entrepreneurs with a dedication that would make the make sales people in the 1980’s Pulitzer Prize winning play Glengarry Glen Ross look like rookies. These corporates include media business, telecommunication businesses and banks to name just a few. Some of them decide to get in at early stages through accelerator arms or corporate ventures while others focus on acquiring existing high-growth businesses. What they have in common is that are willing to allocate the resources to get into the game.
We have Google with its well-known venture activities, Amazon investing every dollar earned into new businesses, and we have significant corporate venture activities. In a way, we see a pattern of these businesses turning into conglomerate incubators. Now what is all of this about? What’s the driver behind this pattern of companies increasing their early stage activities?
As I mentioned earlier, these companies could be looked at as conglomerates. However, this comparison misses an important point: there is a strategic rationale for many of their investments.
Partially these companies have to pursue these activities. Markets have changed in many ways since Warren Buffet started Berkshire Hathaway. The speed of change has increased, partially due to the decline of entry barriers. I recently wrote an article that discusses this development in more detail; using GoPro as a case study to show how success factors of businesses change as entry barriers have declined.
In order to stay competitive, companies have to adjust. Clayton Christensen’s disruption theory explained to us how established players get displaced by new entrants. As a result, today even the most traditional government official is aware of the dangers of being disrupted. Facebook acquired WhatsApp for this huge amount of money because younger people are more happy to use mobile apps like WhatsApp instead of Facebook.
Yet not only the threat of disruption drives activities in new fields. There is additional strategic logic to such investments.
One reason is that markets have become more integrated. If you think of companies such as Buzzfeed or Netflix, it’s clear that technology has become a success factor for media companies. The job board on Buzzfeed’s website doesn’t resemble the job board of the early Times Magazine. The inverse of that is that media plays a role for technology companies. When we buy consumer electronics products such as tablets, then the software and the content that it can deliver are a key factor that drives our purchase decision.
Further, businesses tend to consist of ecosystems or platforms. Controlling these platforms can be critical, which is also the reason why the consumer electronics company Apple and the software / media company Google became competitors. Theirs was a competition about controlling the next platform, iOS vs. Android.
Platforms are central to even smaller markets. WordPress is a platform. Evernote is a platform on which further services are built upon. There will be a logic for companies today to invest in building the next platform.
Similarly, Amazon offers e-commerce on one side and infrastructure on the other. This sounds like two different businesses. However, every product that Amazon builds can run on its infrastructure platform, turning Amazon into its own service provider. As stated in the a16z podcast, it’s the “ultimate eat your own dog-food.”
Not every activity may turn out to be successful. But we see a common pattern that those conglomerate incubators invest in new businesses surrounding their core markets. And unlike Berkshire Hathaway’s investments, the businesses they invest in provide high growth potential combined with high uncertainty. Their success is hard to measure. It’s hard to come by a Berkshire Hathaway portfolio company that would cause as many opinionated discussions as Facebook’s acquisition of WhatsApp or as the future of self-driving cars.
Looking into the future
As Google turns into Alphabet, as Facebook bets in new platforms and as corporates form accelerators, we have to learn to assess these companies in a different way.
While assessing the future prospect of Coca Cola requires a similar skill set as assessing Berkshire’s Fruit of the Loom, assessing self-driving cars requires a different skill set from assessing Google’s search engine. If you compare Berkshire’s portfolio with Google X’s aim of developing “science fiction-sounding solutions”, then soda suddenly may not be too far away from underwear.
On the one hand, we need to get more comfortable with assessing businesses that invest today’s profits into future revenues. As these companies leave their comfort zone, we have to do the same when we want to understand them. And it will also require us to focus on different and more forward-looking metrics as Mark Suster’s article at Both Sides of the Table exemplifies. He goes into much depth about the tension between generating profits today and investing in growth.
On the other hand, quoted companies will have to think about making the life of the media and of investors easier, as Google / Alphabet just did. The conglomerate incubators need to find both organization forms as well as communication strategies that reflect the diverging risk profiles of their businesses.