Google: What Goes Up...

Ad clicks are flat, the stock is falling. Can the enchanted corporate giant keep the magic from fading?
Justin Wood

Google (GOOG) is finally discovering gravity. First, the company missed Wall Street revenue forecasts in the fourth quarter for the first time. Then a pair of reports from market researcher comScore (SCOR) , the latest on Mar. 26, said U.S. growth in the number of clicks on the paid ads appearing next to Google's search results essentially flatlined for two months running compared with a year ago. Six months ago, paid clicks were growing up to 40% annually.

The combined news was enough to send sentiment about Google crashing to earth. Its stock price has plunged 38% from its all-time peak, an intraday high of $747.24 last November, one of the worst performances by a blue-chip tech stock. The big worry: A tanking economy could ground the company's unparalleled rocket ride. "The whole Street has turned cautious," says American Technology Research analyst Rob Sanderson, who notes that 16 analysts out of about three dozen have cut Google's first-quarter profit estimates. "Everyone's scared."

Perhaps such a sudden shift in momentum was inevitable for a company that seemed nearly invulnerable thanks to a hugely profitable business and search technology so useful its very name became a verb. But it also may signal that the company is facing a moment of truth, one that previous tech phenoms such as Microsoft (MSFT) also faced: Can it hold on to the magic that has made it perhaps the world's most enchanted corporation?

Departures from google

New challenges are piling up. For one, some key people are leaving for new, potentially more lucrative opportunities. They include Sheryl Sandberg, the top sales vice-president who departed last month to become chief operating officer at Facebook, and Douglas Merrill, a high-profile engineering vice-president who will leave Apr. 28 to be EMI Music's president of digital business. Moreover, Google's seemingly scattershot attempts to find new avenues of growth in everything from online video ads to office software to wireless communications so far haven't produced much revenue. And rivals from startups such as Facebook to behemoths such as Microsoft are intensifying their attempts to capture large new chunks of online commerce before Google does.

Much of the concern about Google's business could prove unfounded. When the company reports first-quarter results on Apr. 17, revenues are expected to surge at least 40%, to $3.5 billion, while profit per share will likely rise 22%, to $4.50, despite a hiring binge last year and higher research and development costs. Google CEO Eric E. Schmidt and other executives maintain they're not yet seeing an impact from the economy.

Still, it's unclear how well Google's unusual management will be able to deal with the more challenging times. The triumvirate of Schmidt and cofounders and presidents Sergey Brin and Larry Page has encouraged a unique, just-do-it culture that helped it get this far this fast.

But the eccentricities investors found charming when the stock was soaring may test their patience if shares continue to fall. The company provides no guidance to financial analysts.

It gives its engineers about a day a week to work on personal projects outside the direct scrutiny of their managers, making it tough even for insiders to know who's doing exactly what. And its ad business, ruled by secret, complex mathematical formulas, vexes analysts, who label the company a "black box."

Not Immune to the Slowdown?

That's why data trickling out over the past couple of months have so shaken up some Google boosters. Google contends the apparent flattening of paid clicks is purposeful. It has reduced the clickable area around ads to eliminate accidental clicks that don't represent serious visitors or buyers. As a result, analysts say, the average price per click on search words that advertisers bid on rose 15% in the fourth quarter. Yet skeptics abound. "I've seen some softness that looks to be driven by the economy," says Kevin Lee, executive chairman of search-marketing firm Didit.

Google also faces more competition because of its own unbridled ambitions. Last year it began a concerted push to offer software programs online such as e-mail and word processing, in competition with Microsoft. With its just-closed $3.2 billion purchase of DoubleClick and its 2006 buy of video site YouTube for $1.6 billion, it's also ready to plunge into display and video ads. And despite losing a bid for wireless spectrum recently to Verizon Wireless (VZ) and AT&T (T), it's forging ahead with plans for wireless Internet software.

Unlike in search ads, Google must contend with credible and often large competitors in all those markets. "That's not something they've had to do before," says Geoffrey Moore, managing director of strategy consultant TCG Advisors. Most of all, Google faces a Microsoft that has been in "kill Google" mode for well over a year—spending billions on ad-related acquisitions and making an unprecedented $45 billion bid to buy Yahoo (YHOO).

Trading In for Twitter

Like other highfliers that could do no wrong for so long, Google faces key challenges that could well prove more internal than external. Its very success has created a company so big that some veterans are now feeling restless. Besides the executive departures, a number of engineers have left for startups such as microblogging service Twitter and social media sharing site FriendFeed. And with the stock price down so far, employee retention issues could spread, too. Hundreds or even thousands of employees are holding stock-based grants with strike prices higher than Google's shares.

So far the company remains a magnet for young techies. Tom Kosnik, a professor of management science and engineering at Stanford University, says students are attracted to the creative culture, as much as the free gourmet food and college atmosphere. Still, for the first time, the enchanted corporation may need to search for new ways to maintain the magic.

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