Tech

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

In less than a year, the company formerly known as Google has flipped the financial narrative.

At this point last year, investors were annoyed that Google was having growth problems and seemed to be spending like a drunken sailor on shore leave. Now, Alphabet is in Wall Street's good graces for ringing up healthy sales numbers again and, more importantly, for putting that spendthrift sailor in the brig. 

Yet one part of the company has continued to run loose.

Spending on research and development has crept up to record levels even as other operating and capital expenses have dipped or stayed relatively steady. The R&D spending is likely no cause for worry yet as long as the company maintains its recent growth trajectory. 

Fueling Google's Tech
Spending on research and development has crept up at Google's parent company to record levels
Source: Bloomberg

The company hired Ruth Porat as chief financial officer in May 2015, and the former Morgan Stanley executive started to talk tough about putting Google on a spending diet. In her first earnings conference call with Wall Street last July, Porat said the company was focused on "the levers within our control to manage the pace of expenses while still ensuring and supporting our growth."

In that first quarter under Porat, the company's operating expenses rose 13 percent compared with those in the period earlier -- the slowest rate since 2013. The trend has continued since then in two of three main categories of operating expenses.

Breakout Star
Shares of Google's parent company were in a rut until July 2015, when the company posted fast revenue growth and expense discipline
Source: Bloomberg

Expenses for sales representatives and marketing costs were 12.3 percent of revenue in 2014, a record high for the company, but eased down to 11.8 percent in the first quarter of 2016. Spending on general and administrative costs fell in each of the last two quarters, the first time that category fell during a six-month period, according to data compiled by Bloomberg. Alphabet's capital expenditures -- spending on hard assets like computing data centers and real estate -- have also declined since 2014.

Porat's arrival, a revival of the company's growth rate and the spending diet helped shift investors' attitudes about Google. After shares treaded water for 2014 and the first half of 2015, they shot up 20 percent from the July 2015 earnings report to Friday. 

Uneven Cost Controls
Google's parent company has held steady or decreased two out three main categories of operating expenses. But spending on research and development has picked up.
Source: Bloomberg and company filings
Figures shown here are operating costs as a percentage of total revenue.

But spending on research and development has continued as if the cost-management strategy never happened. The last three quarters were the highest rates of R&D spending as a percentage of revenue in the company's history, according to data compiled by Bloomberg. R&D expenses were 16.6 percent of revenue in the first quarter. At the same point two years earlier, R&D costs were 13.8 percent of revenue.

Most of the R&D expense is for engineers and other technical employees who are arguably the most important fuel for Google's revenue. And even with the pickup in R&D, revenue has grown even faster in each of the last two quarters. 

Fortunately for Alphabet, R&D is likely one area where investors don't mind the old ways of spending -- as long as growth continues to keep pace. If it doesn't, the investor unease about the company's costs may return to the bad old days of 2014 and early 2015.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net