Google Plays Smart Defense by Buying Nest

Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”
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I have been thinking about Google's acquisition of Nest Labs last week for the eye-popping sum of $3.2 billion. There have been numerous criticisms of the acquisition in terms of cost, with some chatter of this as evidence of a bubble in Silicon Valley. Perhaps it is worth considering this from a different perspective.

If we look at some of the biggest tech errors of the past decade, we see a very specific risk arising to existing companies from new technologies. The two that come to mind are Blackberry ignoring the threat from touch-screen smart phones (Apple iPhone) and Microsoft ignoring the tablet as a threat to its basic Windows/PC business (Apple iPad).

Note that Google's Android acquisition allowed the company to be stay competitive with Apple's disruptive technologies -- even as the two previous leaders fell dramatically from their prior spots. Android phones are ahead in market share (but not profitability) versus the iPhone; Android tablets are the default alternative to iPads. Blackberry saw its market share plummet. Microsoft is encountering a seismic shift in PC sales.

Give credit to Google for having the tech foresight to see a potential threat to its main business -- selling advertising against search results -- from the mobile space. The Android acquisition gave Google a solid footprint in mobile search, preventing it from having to play catch-up as Blackberry and Microsoft are.

Briefly consider the counter-factual -- what the future might look like had these purchases never occurred. We can only imagine the conversations that would be occurring in Mountain View, California, today had Google not purchased Android. And the vast traffic going to YouTube would be going elsewhere had Google not purchased the video site in 2006.

Is Nest Labs the sort of acquisition that will look like a no-brainer years hence? It certainly has the potential. Most of Google's other home-oriented technologies have failed to catch on in a major way. Android@Home platform simply never caught on, and the Nexus Q streaming media device is not exactly lighting the world on fire. And please, don't even ask about the Chromecast Dongle.

Google has put together a pretty good track record of acquisitions. YouTube was a huge winner, giving Google a dominant position in online video. The company's stock price increase after the YouTube acquisition was announced practically paid for purchase. Even the purchase of Motorola Mobility -- which, at $12 billion, also sounded pricey at the time, and looks like a bust in terms of sales -- was a clever patent acquisition; it has worked to mostly insulate Google from mobile patent-infringement lawsuits.

Meanwhile, the Wall Street Journal reports that Nest Labs is selling 100,000 smart thermostats a month -- that's mighty good for a two-year-old product from a start up.

While $3.2 billion is a lot of money to you or me, its barely 5 percent of Google's cash, and a pittance (less than 1 percent) relative to its $388.8 billion market cap. The risk to Google is not the cost of making such acquisitions, but the potential risk to its core business down the road of failing to do so. If the "connected home" is a thing a few years hence, what new or existing company might be doing to Google what Apple did to Blackberry?

I suspect that a decade from now, this may end up looking like another smart acquisition.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

Barry Ritholtz writes about finance, the economy and the business world for Bloomberg View. Follow him on Twitter @Ritholtz.

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Barry L Ritholtz at