Partner Pay Intrudes on Google Fantasy

The folks at Google would have you believe that they've modeled their company on the principles of Warren Buffett.

But investor beware: The more appropriate comparison is Willy Wonka.

In their letter to potential shareholders that was included in Google's initial public offering documents filed Thursday, Google founders Larry Page and Sergey Brin paid homage to the values of Berkshire Hathaway's ( BRKA) Buffett: the focus on creating long-term value, not hitting quarterly numbers. The blunt, plain-spoken communication with shareholders. And, one assumes, the promise of fabulous wealth.

Yet the picture they paint of how Google is run, and how it should be run, more closely resembles the candy manufacturer run by Willy Wonka in Roald Dahl's classic children's book Charlie and the Chocolate Factory.

Wonka's chocolate factory is a magical, wonderful place, for those of us lucky enough to get a peek inside its iron gates. But in another light, it represents an preadolescent fantasy. With its chocolate waterfall, its workforce of happy Oompa-Loompas and fantastic inventions like chocolate transported by television, Wonka's factory is certainly the way you wish chocolate would be manufactured.

But in the harsh environment of capitalism, one wonders how long the fantasy can really last. That's equally the case at Google, which boasts financials that for now are the envy of the Internet but could soon be squeezed by growing competition from deep-pocketed rivals.

Tech Playground

The parallels between Wonka and Google's founders are striking. Both Wonka and the Googlers are legendarily secretive. Both have utter control over their operations and plan to keep it that way -- Page and Brin through a two-class stock structure, and Wonka by giving his factory to a child who will listen to him, not to a grown-up who "will try to do things his own way and not mine."

Both are obsessed with their research labs: Wonka has his Television Chocolate and his Everlasting Gobstoppers; Google encourages employees to spend 20% of their time on research and development, and calls its Google Labs Web site "our playground for our engineers and for adventurous Google users."

Both appear to be beneficent employers with hints of paternalism: Wonka rescues the Oompa-Loompa tribesmen from their bleak existence so they can work in his factory; Brin and Page tell us they provide their employees meals free of charge, doctors and washing machines. "Expect us to add benefits rather than pare them down over time."

Finally -- and most relevant to investors -- neither Wonka, nor Google's Brin and Page, seem all that interested in making money. Google's mission is "to organize the world's information and make it universally accessible and useful," and they're guided by the motto "Don't be evil."

Not that there's anything wrong with treating your employees well, or not being evil. But the idyllic picture painted by Google's IPO document looks very much like life inside a late-1990s dot-com start-up. You've got unlimited free soda in the refrigerator, free massages on Friday and a sliding board from the second floor to the first. If you follow your joy, the money will follow you.

In other words, it's a business based on an unlimited supply of free money. Sure, Google will get that money from an IPO. But it won't last forever.

For the first glimmers of the new reality, consider the economics of Google's relationship with other companies upon whose sites Google runs ads, and through which Google collects advertising revenue.

Those partner sites -- referred to as members of the Google Network -- accounted for a significant amount of Google's gross advertising revenue, one learns from Google's IPO document. In 2003, those partner sites generated $648 million in gross revenue, or 46% of Google's $1.4 billion in gross advertising revenue.

Yet Google's net revenue from its partner sites -- the amount it receives after it pays commissions to these partners for the privilege of running ads on their sites -- is a fraction of that. According to's calculation, in 2003 Google paid to its partners 81% of the advertising revenue it received from these partners. In comparison, Google rival Overture Services, before it was acquired by Yahoo! ( YHOO) last year, was paying out around 63% of partner-generated ad revenue to its partners.

Hard Chargers

One can interpret Google's ability to pay out a higher percentage as a sign of its economic strength. But one can just as easily interpret it as a sign that those partner sites, by virtue of their own brands and the traffic they generate, have bargaining power they can exert over Google. As Yahoo! and other companies expand their own efforts in the pay-per-click search market and content-targeted advertising, you can expect that 81% number to increase. Time will tell if the size of the market overcomes the higher traffic acquisition costs.

That comparison to Yahoo! hints at another challenge to the Google ideal: The problem with not caring how much it costs to run your company or develop new technology is that you're competing against people who do care.

Yahoo! isn't the only qualified competitor going after the same money that is collecting in Google's coffers. Microsoft ( MSFT) is hard at work on its own search technology. Time Warner's ( TWX) America Online, which has a small but growing paid search business, could likely end up as another power to be dealt with, given its huge audience and ad-sales experience.

Google has rightly developed a following based on the quality and relevance of its search. But those competitors are no doubt working to improve the quality and relevance of their own search results. And, as we learned from the IPO, Google's exclusive license on one aspect of technology it uses to judge relevance of Internet content will become non-exclusive in just seven years.

There's nothing wrong with running a chocolate factory, or an Internet-search company, any way you please. There's nothing wrong with believing that you'll have infinite resources. But a few years from now, if times get a little harder for Google, investors might begin to question whether the money spent on workplace washing machines might better be deployed elsewhere. Like anyone who might have invested Wonka's fictional factory, there won't be much they can do about it.

And unlike Warren Buffett -- a value investor and all-around tightwad who owns a candy store, See's Candies, himself -- the people in charge may just not care.

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