SAN FRANCISCO -- Google's ( GOOG) innovative paid-search advertising, along with some good old-fashioned belt-tightening, helped it stay healthy during hard economic times. But the question is, how severe do conditions have to get before the company finally succumbs? Most analysts were impressed with Google's ability to grow third-quarter revenue by 31% in the face of a financial crisis, even though it marked a slowdown from its 39% growth in the previous quarter. Shares of Google were up 6.2% to $375.05 in recent trading. A big part of Google's performance can be attributed to its cost containment. The company hired 519 employees in the third quarter, bringing its total worldwide workforce to a whopping 20,123. But that's a much slower clip than a year ago, when Google added 2,130 to its staff. Google Chief Executive Eric Schmidt emphasized on Thursday in a conference call with analysts the need to "keep a very close eye on costs." "It makes sense given everything we read in the papers and we have done that effectively in this quarter," he said. At the same time, paid-search advertising -- Google's main cash cow -- held up well in the third quarter, despite fears that online advertising would contract as advertisers shrank their budgets. Paid clicks, or the number of times a user clicks on an ad, grew 18%, a slight drop from its 19% growth the previous quarter. Sanford Bernstein analyst Jeffrey Lindsay notes that excluding traffic acquisition costs -- or the money that Google shares with its partners -- the company's revenue grew 4% sequentially in the third quarter while its hiring increased by only 2%. That means that Google's staff is working more efficiently, he says.
"If they kept doing that over and over, their profitability would going even higher," Bernstein says. As for paid search, it seems advertisers have been reluctant to cut back in that area since they still see a high return on investment. Bernstein maintains that during tough economic times, advertisers prioritize where they want to spend, and TV and print advertising are the first places they'll cut, followed by online display advertising. That puts companies like Yahoo! ( YHOO) at risk since they rely so heavily on display. Paid search, where Google dominates, is the last resort, and the economy would have to worsen considerably before advertisers pull back from spending there. And apparently, they haven't reached that point yet. Bernstein says the economy may have to slump even deeper for paid search ads to see any significant deterioration. But how deep remains to be seen, assuming that an economic turnaround is still a long way off. For Google, it may be a race against time. The company has been trying to develop other meaningful ways to generate revenue besides through search ads. Next week, Deutsche Telekom's ( DT) T-Mobile will introduce the first smartphone using Google's Android operating system. The company hopes to bring in more dollars through mobile ads. Google has also improved its ability to monetize ads on YouTube. For instance, the online video site now offers click-to-buy videos and CDs, as well as other content. It has also teamed up with CBS ( CBS) to launch full-length videos with stream ads.
Bernstein acknowledges that these efforts may take some time before Google realizes any significant revenue from them. But so far, it has proven that its search ads can hold them over. "They have a long time to get these other products up and working," he says. But Deutsche Bank analyst Jeetil Patel expressed some caution with the company, given its current emphasis on cost containment. "We like the stock and the company's execution amidst an uncertain economic environment, but it is also difficult to lose sight of conference call commentary and buzzwords such as "operational efficiency" and "cost containment" and "disciplined hiring," which (in our years of watching business models develop, transition and mature) truly represent the hallmarks of slowing growth (especially in tech investing)," he wrote in his latest research. Nonetheless, Patel maintained a buy rating on the company, pointing out that "with a substantial focus on cost controls in place, we remain quite optimistic on Google's ability to deploy levers to stoke growth (if necessary) and achieve bottom-line targets in such a difficult industry environment."