Google (GOOG) has been dead money for the last year. Its stock has barely budged -- up just 3% vs. 12.6% for the S&P 500. The Internet giant's overarching problem is its inability to diversify its sources of revenue: It's getting a very low return on its R&D investment. And for potential investors, the question must be: Is new CEO Larry Page taking the right steps to correct that?
Back in 1997, in my book The Technology Leaders, I identified the Four Sources of Advantage -- a set of traits that typify top-performing technology companies.
Starting with a group of more than 1,300 technology companies, I found 20 that seemed able to sustain superior financial performance -- beating their peers in long-term return on equity by 240%, sales growth by 570%, and stock market performance by 450% -- despite waves of new technology that threatened their survival. Those Four Sources of Advantage were the keys to their success: By measuring Google on these traits, we can diagnose its problems and assess Page's efforts to fix them.
Chipping Away at the Value Quotient Problem
Back in January, when Google announced that Page would become CEO, replacing Eric Schmidt, I wrote on DailyFinance that Page would have his work cut out for him based on Google's Value Quotient (VQ), which measures how well a company follows seven principles essential for any company that wants to create a better work environment for its people and provide customers with more bang for their buck. I concluded that Page would need to do a better job of motivating Google's people and coming up with big new revenue sources.
Page appears to be chipping away at some of these challenges. According to The Wall Street Journal, even though he won't officially take over until April 4, he's already trying to narrow down the number of new projects that Google's product and engineering managers are developing, focusing their efforts on the ones that he thinks have the greatest potential.
This made me realize that a more effective way to assess whether to invest in Google would be to look not at its VQ, but a different measure -- its Innovation Quotient (IQ).
Calculating Google's IQ
The Innovation Quotient measures a company based on its scores in 60 attributes grouped within four organizational traits -- the Four Sources of Advantage -- defined briefly below:
Entrepreneurial Leadership. The ability to attract and motivate people with successful track records of starting new companies. An example I used was Cisco Systems (CSCO), which brought many successful entrepreneurs on board through acquisitions of startups, and created a culture that kept them highly motivated;
Open Technology. The willingness to build or buy technology that customers want to buy in order to keep those customers in long-term relationships with the company;
Boundaryless Product Development. Working with teams of so-called early-adopter customers, engineers, marketers, and other key functions to develop prototypes that satisfy unmet customer needs and use the feedback on those prototypes to build products that get to market fast; and
Disciplined Resource Allocation. Systematically shifting resources from low-potential projects to more promising ones and spreading what has been learned about what works and what needs improvement throughout the organization.
About 13 years ago (April 17, 1998 to be specific), Stanford University invited me to talk about this at its Industry Thought Leaders program. Page wasn't in the audience, but if he had been -- and if he remembered now anything I said then -- he might today be looking at the details behind Google's mediocre IQ score of 70 (out of 100) to analyze where it needs to improve:
Entrepreneurial Leadership (15/25). Google is extremely selective about the people it hires -- but then its most talented employees leave for companies like Facebook. Its flat stock price is a big problem: Why would top talent want to work in a bureaucratic organization that slows down their creativity while giving them below-average pay and stock that goes nowhere?
Open Technology (20/25). Google has been good about acquiring companies, but it has been having trouble turning its acquisitions into big sources of new revenue to makes the deals pay off for shareholders. Moreover, it has had trouble retaining the entrepreneurs it acquires, if the 2010 departure of YouTube's Chad Hurley is any indication (Google paid $1.76 billion to buy YouTube in 2006). Its recent decision to acquire social networking application company Slide for $179 million, and then essentially leave it alone, as The Wall Street Journal reported, suggests that it doesn't have a clear vision for its acquisitions.
Boundaryless Product Development (20/25). Google has encouraged its engineers to spend 20% of their time working on new products -- seemingly in isolation from everyone else in the world. There may be some gems in there, but Google has been doing a poor job of building teams to commercialize the ideas.
Disciplined Resource Allocation (15/25). Page's recent efforts to get some discipline into Google's projects is a good first step, but it's hardly enough. Google needs to develop explicit criteria and a formal process for evaluating projects. It also needs to do more to spread its knowledge of what works, such as its project -- reported on in The New York Times to define a good Google manager. Based on that study, Google found that its best managers made time to help solve employees' problems and gave them specific goals and clear feedback.
Google needs to apply this same learning mentality to making the improvements I suggested above. The good news is that Google is a smart company, and Page is a smart leader. His efforts to streamline R&D projects are good, but he needs to do much more to attract and motivate entrepreneurial leaders. If he does, Google could become a good investment again. But until it demonstrates more progress on boosting its IQ, I would avoid Google's stock.
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