Google's Wireless Gamble

The Web search giant, rocked by slowing ad growth and a plunge in its shares this year, is crafting a cell phone operating system to thwart Microsoft and put its name on millions of mobile screens.

By Edward Robinson and Ari Levy
Bloomberg Markets May 2008

On a chilly February morning, Andy Rubin hustles past equation- filled whiteboards in a two-story building on Google Inc.'s Silicon Valley campus. Rubin, a computer scientist who builds robots for fun, has spent three years in this top-secret sanctum of the Googleplex. He's putting the final touches on one of the most ambitious--and potentially humbling--projects the Internet juggernaut has ever undertaken: an operating system for cellular phones that's designed to give Google the same grip on the mobile Web that it commands in online searches on personal computers.

"We've gotten to the point where anyone can build a cell phone," says Rubin, 44, dressed in blue jeans and a red crewneck T-shirt as he explains why Google is piling into wireless, the Internet's new frontier. "What's important now is software, having the next cool application."

After luring an audience that tops 588 million people who search in more than 200 languages and winning 72 percent of the $22.5 billion in annual advertising linked to Web queries, Google founders Sergey Brin and Larry Page are hunting beyond the PC for growth. Fewer googlers are clicking on the text ads that run alongside Google's search results, threatening the area that generated most of the company's $16.6 billion in 2007 sales. In January, such clicks fell 7.5 percent from December, Internet research firm ComScore Inc. reported. ComScore said this didn't necessarily mean Google would record less revenue in the first quarter. Still, coming after the fourth quarter, when earnings of $3.79 a share fell short of the $3.91 average analyst estimate, investors feared the weakening economy was taking a toll. Google shares, among the hottest on the planet as they soared eightfold after the company's Aug. 18, 2004, initial public offering to a high of $741.79 on Nov. 6, 2007, have tumbled this year. On March 7, they traded at $433.35, a drop of 37 percent in 2008 and a 42 percent plunge from their record close.

The looming presence of Microsoft Corp. is amplifying investors' anxiety. In February, the world's biggest software company made a $44.6 billion unsolicited bid for Yahoo! Inc., which is No. 2 behind Google in Web searches. Yahoo rebuffed the offer on Feb. 11, saying that it undervalued the company. Since then, Yahoo has deliberated about how to counter the proposal, leaving Google shareholders on edge. "The slow click-through rates are a concern,'' says Donald Bessler, chief investment officer of Winward Capital Management, a Los Angeles investment firm that holds 535 Google shares. "Throw in the possible Microsoft-Yahoo merger and you have a lot of people getting out of the stock.''

Turning to telecom won't make Google's life any easier. Microsoft already enjoys 21 percent of the U.S. market for mobile operating systems. Winning Yahoo would give the software giant the most popular site on the mobile Internet, with 28 million combined subscribers, according to M:Metrics Inc., a Seattle-based research firm. That compares with Google's 14.5 million. Meanwhile, the phone companies that control the wireless networks aren't likely to bow to Google at the expense of Apple Inc.'s iPhone and other hot products. Ralph de la Vega, CEO of AT&T Inc.'s wireless division says a so-called "Google phone" could likely become just one of the many offerings in AT&T stores.

Ultimately, Brin and Page haven't proved they can do anything else as well as they do search, says Laura Martin, an equity analyst at New York-based Soleil Securities Corp. who rates Google stock a "hold" because she's wary about whether the company can keep growing as it has. In January, Brin said on an earnings call with analysts that Google had yet to make headway in selling ads on MySpace and other social networking sites. In instant messaging, Microsoft's Windows Live Messenger enjoyed 235 million unique visitors in January, according to ComScore. The Google Talk messaging service is approaching 5 million users. "Despite relentless product introductions, the only one that's been a proven economic success is search," Martin says. "Until Google can show that it's not a single-product company, there's no guarantee that it can sustain its growth rate."

Winning on the mobile Web, one of the biggest and potentially most lucrative Internet markets, would take Google far in erasing such doubts. There are more than 3.3 billion cell phones worldwide, about one for every two people on the planet. By 2010, that's expected to jump to 4 billion, or triple the number of personal computers, according to research firm Gartner Inc. Brin and Page want the first page callers see on these phones to be Google's. From there, users would tap Google software to surf for information, e-mail friends, watch videos and find the nearest deli, just like they do on PCs.

"It should be possible that the primary place you search would be a mobile device," Google Chief Executive Officer Eric Schmidt says. He predicts cruising the Web on handheld gadgets may eventually rival the wired search market, meaning mobile might someday account for roughly half of Google's revenue.

Schmidt's prediction puts the spotlight on Rubin and his team of engineers--and their operating system called Android, which is set to hit the market this summer. Unlike Microsoft, which licenses Windows Mobile to handset manufacturers, Google plans to give Android to scores of cell phone makers and service providers. It has formed the Open Handset Alliance with more than 30 phone manufacturers, carriers and chipmakers to support Android. Among them are Motorola Inc. and Japanese carrier NTT DoCoMo Inc. To pave the way, Google has already released mobile versions of its search and other software that can run on the iPhone, for one.

Google is betting that Android and its made-for-mobile-phone programs will attract millions of customers who can be plied with ads--just like Google does on PCs. Mobile online advertising in the U.S. is forecast to jump to $4.8 billion by 2011 from $1.6 billion this year, according to research firm EMarketer Inc.

"The cell phone is where it's all moving, and Google has to get into that," says Rich Redelfs, a venture capitalist at Foundation Capital in Menlo Park, California, who invests in wireless technology companies. "The operating system has incredible power, as we've seen with Microsoft. So Google wants to create an operating system that can go across handsets and give them a stronghold."

If any other newcomer set out to shake up the mobile world as Google is doing, telecom veterans would dismiss it out of hand, says Richard Wong, a venture capitalist at Accel Partners in Palo Alto.

Google isn't any company. It's a force so synonymous with the Internet that the Oxford English Dictionary recognizes Google as a verb. A decade after its founding, Google, with its market value of $136 billion, is the Valley's byword for wealth and buzz. Brin, 34, and Page, 35, who were Stanford University Ph.D. computer science students when they devised a formula to rank and display Web searches by their relevance, are each worth more than $13 billion and wing around the globe in a Boeing 767. Former U.S.

Vice President Al Gore, who won the Nobel Peace Prize last year for his crusade against global warming, advises Google's board. Internet pioneer Vinton Cerf, attracted by Google's reputation for innovation, holds the title chief Internet evangelist. Democratic presidential candidate Barack Obama spoke to a packed house at Google headquarters in November.

On March 11, Google bolstered its ability to deliver online ads with video and images by winning approval from European Union antitrust officials for its $3.1 billion purchase of DoubleClick Inc. The U.S. Federal Trade Commission cleared the deal in December.

"Google sneezes, and everyone goes bananas," says David Weiden, a venture capitalist at Khosla Ventures in Menlo Park, California, just up the road from Google's Mountain View headquarters. "But just because it's Google, doesn't mean it wins."

Cracking the $135 billion U.S. wireless industry will be tough, even for Google. The market is more entrenched and better defended by incumbents Verizon Communications Inc. and AT&T than the wired Internet, Accel's Wong says. BlackBerry maker Research In Motion Ltd., Palm Inc. and now Apple are dueling for customers. Finnish phone giant Nokia Oyj owns 48 percent of Symbian Ltd., a London- based software firm that commands almost two-thirds of the global market for mobile operating systems. Then there's Microsoft, whose Windows Mobile runs gadgets offered by 160 phone companies in 55 countries.

"Google is picking some really big fights," says David Helfrich, a partner at Garnett & Helfrich Capital, a San Mateo, California- based technology buyout firm. "I'm not convinced that Google, for all the billions of dollars it has, can be the No. 1 Web company and the No. 1 mobile operating system. They're not omnipotent."

Microsoft may release the seventh generation of Windows Mobile this year, just as Android makes its debut. "Microsoft versus Google--that's the battle that's coming in mobile," Terry Garnett, Helfrich's partner, says.

The looming fight between two of the most powerful tech companies promises to open a new front in their all-out war for Internet domination. Microsoft's bid for Yahoo intensified the rivalry. Invoking Microsoft's antitrust woes from the late '90s, Google Chief Legal Officer David Drummond questioned whether the Yahoo offer was another power grab. "Could the acquisition of Yahoo allow Microsoft--despite its legacy of serious legal and regulatory offenses--to extend unfair practices from browsers and operating systems to the Internet?" he wrote on Google's Web site on Feb. 3. On Feb. 27, the European Union fined Microsoft a record 899 million euros ($1.35 billion) for failing to comply with a 2004 antitrust order related to Windows for PCs.

In a letter to the Yahoo board dated Jan. 31, Microsoft CEO Steve Ballmer highlighted Google's power in online advertising. "The market is increasingly dominated by one player who is consolidating its dominance," he wrote. "Together, Microsoft and Yahoo can offer a credible alternative."

A potential Microsoft-Yahoo combination is turning up the pressure for Rubin to make Android deliver in mobile. An energetic man who talks with the speed of an auctioneer, Rubin falls back on geekspeak when he describes his mission. Leaning forward at a conference table in Google's mobile technology lab, he says Android will use "end-to-end connectivity" to make phones "intelligent." Translation: Android will let mobile users constantly update their phones by downloading thousands of different programs, from games to social networks to videos. "It's changing the consumers' expectations," Rubin says. "They go into a store and buy a piece of physical hardware, and it gets better over time."

Rubin has been fixated on mobile technology for more than 15 years. He grew up in Chappaqua, an upper-middle-class suburb north of New York. After earning an undergraduate degree in computer science from Utica College in upstate New York, he went to work in robotic engineering. Over the years, he's tinkered with dozens of robots, such as the XR4000, a 4-foot-high (1.2-meter-high) cylinder on wheels that looks like an industrial-strength vacuum cleaner. His current project is a desk-sized helicopter rigged with a global positioning system, which he directs by clicking on a Google Maps screen on his laptop. A digital camera attached to the aircraft snaps panoramic aerial photographs, occasionally buzzing the Googleplex. "Robots are interesting because they're like infants," he says. "There's a lot of trial and error."

Rubin did his first work on operating systems for mobile devices in 1992 at General Magic Inc. The company, a pioneer in technology for personal digital assistants, had been spun out of Apple two years earlier. After detouring into an Internet television startup that was acquired by Microsoft in 1997, Rubin was ready to start his own firm. In 2000, he co-founded Danger Inc., which made the Hiptop, later dubbed the Sidekick, one of the first portable phones primed for the Web. Its pop-out screen and full alphanumeric keypad became all the rage among Hollywood celebrities. In 2005, the phone made headlines after a report that socialite Paris Hilton's Sidekick was hacked and her contact list posted on the Web.

By then, Rubin had moved on. In late 2004, he says he realized that at long last the wireless industry had reached a turning point. Handsets were becoming full-blown computers. Unlike the PC market, which was powered mainly by Microsoft's Windows, mobile was a chaotic bazaar of different operating systems. Motorola, Nokia, Palm, Research In Motion and later Apple all built their gizmos with proprietary operating systems. Microsoft's Windows Mobile, while making inroads, didn't match the clout of its PC counterpart, which today controls 95 percent of the market. With no dominant software maker in mobile, Rubin saw an opportunity. He and three colleagues co-founded Android Inc.

As it happened, Brin, Page and Schmidt were also convinced the time was right to jump into mobile. Schmidt, 53, who holds a Ph.D. in computer science from the University of California, Berkeley, found he talked the same technical lingo as his younger counterparts. As chief technology officer at Sun Microsystems Inc. from 1994 to '97, Schmidt led the development of Java, the programming language that fueled the growth of the Web by letting different applications talk to one another.

In 2001, Page, then CEO, and Brin, who was president, interviewed Schmidt for the Google chief executive job. The pair mused that Sun's best days might be past and the company wasn't worth buying anymore, Page said in a lecture to Stanford students in 2002. Schmidt countered with Sun's merits. Page, who said he and Brin like a spirited debate, were impressed. "We had a good argument, and he really enjoyed it," Page said in his lecture. "As a result, he came to work for us." Brin and Page declined to comment for this story.

Officially, Page, who grew up in East Lansing, Michigan, is now Google's president of products. Brin, a native of Moscow, is president of technology. In practice, Google is led by three co- CEOs, with Schmidt bridging the engineering and sales realms, says Ken Anderson, director of global information technology from 2003 to '04.

As Google's ruling trio sized up the mobile world in '05, they faced a sobering reality: Americans didn't surf the Web on handheld devices. Only one in five had even bothered to try, according to Forrester Research Inc. There were plenty of reasons.

Many phone companies charged a premium for Internet access, with the meter always running like a taxicab's. When consumers did pay, they often embarked on a slow journey hampered by no mouse and few programs available for a small screen. Phone carriers, which collect about 85 percent of their revenue from voice and text messaging, saw little need to throw open their "walled gardens" to new Web-based applications, says Jason Devitt, CEO of Skydeck Inc., a San Mateo-based mobile software startup. As the owners of the networks, they had the power to decide which applications could run on their phones. "For 20 years, all the focus has been on getting a dial tone," Devitt says.

How would Google ever build a mass audience on the mobile Web if few people used it? Enter Android.

Rubin had first met Brin and Page at a lecture he gave on mobile technology at Stanford in 2002. In a series of sit-downs with Page in early summer 2005, Rubin described how his open operating system would attract consumers by using the Internet to provide scores of different applications. That meshed with the trio's main concern, Rubin says. If the phone companies weren't going to create a better mobile Web experience, then Google would do it. "If Android existed, we wouldn't have to build it," Schmidt says.

Moreover, Google's brain trust saw Android as a lever to shimmy open the carriers' networks. The triumvirate didn't like the idea that phone companies could dictate terms to. "They were frustrated because the cell phone space didn't offer equal access to them; there was the traditional walled garden," Rubin says. If consumers were to fall in love with an Android-powered Google phone because of its ability to constantly be updated with new features, the carriers would have little choice but to make the phone available. Rubin says Brin, Page and Schmidt saw Android as a way to level the playing field.

Wielding Android would also give Google a shot at competing with archrival Microsoft and its Windows Mobile. The Valley still hasn't gotten over how Bill Gates used Windows and his Internet Explorer Web browser to crush Netscape Communications Corp. in the mid '90s. Netscape Navigator was the breakthrough browser that helped turn the Internet into a mass phenomenon. After being purchased by America Online Inc. in 1998, Netscape faded. Time Warner Inc.'s AOL stopped supporting Netscape on March 1; Explorer now controls more than two-thirds of the browser market. Google wasn't about to let Microsoft box it out of mobile.

"Netscape lost the browser wars because Microsoft owned the operating system," Rubin says. "Let's not repeat that in mobile phones."

In July 2005, Google acquired Android Inc. for an undisclosed amount. Rubin and his eight-member team decamped from their Palo Alto offices for the Googleplex. They found an engineering culture that had changed little since the company's early days. Brin and Page were still preaching about how teams of fewer than 10 engineers promote creativity. In his 2002 Stanford lecture, Page said Google would never let the sales or marketing divisions drive development. "I take it as my personal vendetta to stay engineering focused," he said.

Brin and Page still field engineering pitches, and they encourage workers to spend 20 percent of their week on personal projects. Anderson, the former global IT director, says the approach lets the best ideas bubble to the surface. "What works will stay; what doesn't will fade away," he says. Google's e-mail application, Gmail, and its online payment system, Checkout, were developed in this bottom-up fashion.

Google pampers its employees, even by the perquisite-rich standards of the Valley. Its lobby features a grand piano, neon- colored lava lamps and a projection of a Google page showing live queries from around the world. The main cafeteria offers free delicacies from sushi and Indian curries to oysters and steaming stacks of king crab legs. Employees can get free massages, have the oil in their cars changed and zip to meetings on stand-up motorized scooters. Some toilet seats are even heated.

Rubin's plan for Android meshed with Google's culture of openness. From the outset, he based Android on Linux, freely available software code that programmers embrace as an alternative to proprietary operating systems. By using Linux, Rubin hopes independent programmers, from seasoned software pros to pizza- chomping college students, will create hundreds of applications to run on Android. That should make Android-powered phones a hit with consumers and advertisers. Still, Linux, originally created to run servers and PCs, was never intended for devices as small as mobile phones. There's no standard version that telephone companies and manufacturers can rely on for consistent performance. Instead, dozens of flavors clutter Silicon Valley's software development community. For many code writers, it's easier to create for a standardized operating system such as Windows Mobile.

"The Linux community has never been able to consolidate behind one or two commercial versions," says Chris Ambrosio, a wireless industry analyst at Strategy Analytics Inc., a Newton Centre, Massachusetts-based research firm. "That's a problem that Google is going to have to solve."

As Rubin was working on Android, Google was pushing ahead on another cell phone-related front--creating mobile versions of its applications. As it had with Android, it turned to outsiders. In 2004, Google acquired a Valley startup called Zipdash Inc. for an undisclosed sum, gaining software that showed real-time traffic congestion on mobile devices. Two company co-founders, Michael Chu and Mark Crady, were childhood friends who'd studied electrical engineering and computer science at Berkeley. At Google, they, like Rubin, embraced a culture that was more akin to an academic research lab than a for-profit company. No senior managers breathed down their necks with deadlines. They were left alone to pursue whatever project they liked. "Google hires really smart people, and we don't worry so much about exactly what they do," Schmidt says. "We figure they'll self-assemble."

Chu and Crady, both 34, talked about using signals bouncing off cell phone towers to locate mobile users and proposed linking their technology to Google Maps. Before long, colleagues from advertising and internal computer systems joined the group. "There's peer pressure to do cool stuff," Chu says. "If engineers didn't like the project or the people running it, they would go elsewhere."

The pair unveiled My Location in November. With it, a cell phone user can type: "Where is the closest sushi restaurant?" The Maps screen shows nearby eateries, and a user can click on one to call it. My Location is available now on iPhone and other handsets and will be showcased on Android.

As Google's teams prepare for Android's rollout, rivals are going into attack mode. Microsoft is working on improvements to Windows Mobile. In classic fashion, the company is using the mobile operating system to deploy versions of its familiar Excel, Outlook and Word programs, targeting business users. Microsoft has also approved 18,000 outside applications for use on Windows Mobile. Ira Snyder runs the Windows Mobile development lab on Microsoft's Redmond, Washington, campus. A computer scientist who uses phrases like "wicked cool" to describe good ideas, Snyder, 40, says understanding how consumers use phones is key. He employs Ph.D.- level anthropologists, psychologists and other social scientists to study user behavior.

Photos of field work in Beijing cover the windows of a conference room. The pictures, pasted with Post-it notes, show mobile users going about their daily lives. An image of a short-order cook frying up lunch is marked "egg timer" to note one unusual use for a cell phone. "We didn't feel like we knew enough about China," says Snyder, a 19-year Microsoft veteran. "Our job is to make the phone more personal, make it a richer experience. So we just pull people off the street and ask them questions."

Scott Horn, general manager of marketing in Microsoft's mobile communications group, says Google may be in for a rude surprise given the technical difficulty of making software for devices as small as mobile phones. "You can't just hit the download button and bam! The next day you have a phone," Horn says. "Our resources are considerable, and it's taken us years to ramp up. It will be interesting to see how Google meets the challenge."

One way Google is trying to gain traction is by taking its fight to Washington. In July, it helped persuade the Federal Communications Commission to require open access for airwaves that went up for auction in January. The winner of a block of the 700- MHz spectrum must open it to whatever legal device or applications consumers care to use. The two largest American carriers, AT&T's wireless unit and Verizon's mobile division, opposed open access because they didn't want to give up total control of the airwaves, says Michael Nelson, an analyst in New York for Houston-based Stanford Group. Google wanted open access to make sure carriers couldn't block Android and its other applications from airwaves ideally suited for beaming Web pages through walls and buildings. Google pledged to enter a minimum $4.6 billion bid in the auction, which may end by April. Many stockholders are nervous that Google will actually bid to win the spectrum. That would mean building a network and then running a phone company--a venture that could cost as much as $14 billion in capital, according to Mark Mahaney, an equity analyst at Citigroup Inc. who rates Google stock a "buy."

Instead, investors want Google to make a distribution deal with whichever company wins the block. "Google is not in business to run a wireless network," says Jeffrey Donlon, a money manager at Manning & Napier Advisors Inc. in Fairport, New York, which oversees 568,000 Google shares. "I would probably sell my stock if it did."

Phone carriers aren't going to let Google turn their world upside down, says Richard Nespola, CEO of Overland Park, Kansas-based Management Network Group Inc., which advises telecommunications companies. For years, the carriers have been careful to support multiple operating systems to ensure that none dominates them the way Microsoft hammered PC makers. They'll take the same approach with Android. "Google's done an outstanding job of forcing the industry to recognize what's next, but the carriers win anyway," Nespola says. "They control the network, and they can make money from Google opening the network--they're crying all the way to the bank."

De la Vega at AT&T's wireless division says if consumers start demanding the Google phone once it's available, that would just swell the number of AT&T customers and the products available to them. "Android could be one of those choices," he says.

Google doesn't want to simply elbow its way in as one option in a crowded marketplace. Confident in their ability to out-engineer anyone, Brin, Page, Rubin and Schmidt have set out to change the wireless industry so it revolves around Google. "We wanted to create something from a clean slate, a modern piece of computer science," Rubin says. "Windows and Symbian and some of the other incumbents are 20 years old. Computer science has changed a lot."

Upending a market as competitive as mobile telecom is shaping up unlike any challenge in Google's 10-year history. First, Rubin and his team will have to push beyond search into an area where entrenched phone companies are standing guard. Then they must persuade customers that Google-powered cell phones are cool alternatives to models already out there. Finally, they'll need to shake off a Microsoft potentially strengthened by Yahoo and a six- year mobile head start.

For all the ambition and ingenuity that Rubin and the rest of the company possess, this hard-charging giant may find that the mobile Internet is one arena where Google may become synonymous with overreaching.

Edward Robinson is a senior writer at Bloomberg News in San Francisco. edrobinson@bloomberg.net

Ari Levy covers technology in San Francisco. alevy5@bloomberg.net

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