The company is going on a diet. Source: Google
Unlike many companies during and after the financial crisis, Google (GOOG -1.96%) (GOOGL -1.97%) famously decided not to truly cut spending during the Great Recession. Its research and development costs have increased 363% since 2007, from $2.12 billion to $9.83 billion, and its total costs increased 330% during that period. On an annualized basis, those figures are 24.5% and 23%, respectively, as the company invested in its workers and innovation while others recoiled.
Long-term investors have been rewarded by this increased spending, with the stock up nearly 150% on a split-adjusted basis. The investments appeared to bear fruit, as the company's top line grew only slightly slower than its increased investments on an annualized basis (21.7%). More recently, however, top line growth has started to slow. During the last full fiscal year, growth fell to 18.9% and just 12% year-over-year for last quarter -- an ominous sign of things to come.
As such, it is understandable for Google to tighten its belt as top line growth has slowed, and its stock performance has languished. That is what an article from The Wall Street Journal outlines, as it quotes people familiar with the matter. This, however, does not appear to be a slash-and-burn job -- the company appears to be wisely addressing its costs and still making prudent investments for growth.
Strategic hiring that aligns organization to goals
Its newest hiring rules are perhaps the best examples of how Google will become more strategic with capital allocation. According to the Journal, after years of adding staff every year, the executive team is working to select employees to match growth and specific business objectives rather than indiscriminate head count additions. In some ways, Google has already done this, as the company slowed hiring from its average of 2,435 to 1,819 last quarter. The article mentions Google's struggling social media division, Google+, as an area where hiring has been capped.
More broadly, it seems Google is transitioning from a de facto "use-it-or-lose-it" model of capital allocation to a more strategic one. One of the biggest complaints of the United States government by deficit hawks is the use-it-or-lose-it model where agencies spend money to avoid the appearances of surpluses, as they fear surpluses will lead to future appropriation cuts.
However, although it is less reported than government spending, this happens with companies as well, as in some cases divisional managers can increase head counts unnecessarily for pure vanity. The flip side of lower resources, however, is the Fiefdom Syndrome that plagued the Microsoft of yesteryear, where managers actively colluded against other divisions for resources and attention. Fortunatey, I do not think the modest spending cuts and culture at Google will allow this extreme scenario to take hold.
What about that top line?
What expense cutting does not do, however, is grow the top line. And that is what's ailing Google right now. As previously mentioned, first quarter increased just 12% year-over-year. And while that is phenomenal for most large-cap companies, investors expect more from Google, and many have noted slower year-over-year aggregate click rates and lower cost-per-click figures. In addition, cutting expenses has the potential to hurt the top line, as lower investment generally leads to less innovation.
That said, I think the company is wise to tighten its belt. Google appeared to be the poster child for profligate spending with its famous Google X moonshots such as a self-driving car, drone delivery projects, Google Glass, and Project Loon (the balloon-based Internet service system). Pruning some of these low return projects for the short-term is a wise move.
Finally, the timing of this story is rather odd. While venture capitalists provided the scoop to the Journal and not the company itself, the announcement that Google is looking to cut expenses seems rather odd three days before earnings. While it is a fool's (lowercase, of course) errand to try to trade earnings announcements, and we believe in long-term investing (and the long-term value of an investment with Google), an early leak of the expense reduction news is not the most positive sign for short-term investors.
