Don't Look Now, But Google Just Goofed

Don't look now, but Google (GOOG) just goofed. Big time.

For years, the Internet search giant cast envious eyes upon archrival Apple (AAPL) and its ever-growing empire of iDevices: iPods and iPads, iPhones and iTVs, iClouds and Siri. (Note to Apple: I think you put the "i" in the wrong spot on that one.) And now, Google plans to do something about it.

Last week, rumors began emerging of a planned Google-branded wireless entertainment device. This could be another aspect of the Google TV reboot. The timing -- post Motorola merger -- suggests Google may parlay Motorola's TV set-top dominance into a new consumer electronics product for television. But right now, Google's initial aim will be limited to working up a sort of whole-house stereo system -- a stereo that's wireless, everywhere-accessible, and programmable through an Android smartphone.

Sound good? Actually, what it should sound like is ... familiar.

Here Be Dragons

Here's the thing: All this time that Google has kept Apple in its crosshairs, it should have been paying attention to Cisco Systems (CSCO) instead. Because not that long ago, Cisco made the same mistake Google is making today -- and it almost killed the company.

In 2009, Cisco announced a foray into the consumer electronics business. The company that built "the Internet backbone" hoped to increase Internet usage, thus driving demand for more of its bread-and-butter switches and routers. Building off a base in Linksys home routers, Scientific Atlanta DVRs, and the Flip camera phone, Cisco would develop a whole family of products that would more firmly embed the Cisco brand in consumers' lives. These products included the Cius tablet, the (improbably expensive) umi home videoconferencing system, and -- before them all -- the Cisco "Wireless Home Audio system."

If you don't own one of these gadgets now -- indeed, if you've never even heard of Cisco's stereo -- that's no surprise. Poor performance at the company's fledgling consumer electronics division had activist investors calling for radical moves at Cisco last year: selling the CE unit, or shutting it down. Some folks even demanded a breakup of the entire company.

Ultimately, Cisco dodged a bullet, and as demonstrated by last week's earnings, got itself back on the path to recovery. But this required significant structural changes to Cisco's organization, and closing down the Flip business at a $300 million loss.

Could Cisco's past be Google's future?

When Google Was Great

The parallels are unnerving. Much like Cisco, which started in Internet infrastructure, then branched into consumer electronics, Google rose to greatness doing one thing well -- providing free, ad-supported Internet search. Google grew bigger by expanding its ad market into smartphones, offering free Android software to hardware makers. That was great -- but actually building the hardware is something else entirely.

For one thing, selling CE hardware is low-margin. Google's software-centric business model boasts 30%-plus operating profit margins. In contrast, CE companies like Panasonic and Sony barely break even. CE is also terribly competitive. Google owes its massive Internet search profits to the fact that it's the go-to option in search. Every day, Internet users conduct two Google searches for every single search conducted on all other platforms combined.

Not so with consumer electronics. Google's "stereo" (and any harebrained CE ideas Google comes up with subsequently) will have to contend with Sony, Panasonic, Apple, Microsoft, and a dozen other CE specialists besides. This will be no great moneymaker for Google.

When All You've Got Is a Hammer ...

It's no mystery how Google fell into this trap. If a bright operator like Cisco can look at Apple's success in CE and think "We can do that, too," Google can be forgiven for making the same mistake. In fact, Google probably deserves a special pass on this goof because of the way it fell into it.

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Goaded by Apple's incessant patent litigation, Google bought Motorola for its trove of smartphone patents ... but wound up in possession of Motorola's hardware business, too. It was only natural for Google to look at this new hardware subsidiary and think, "We should do something with this."

After all, as the saying goes, when all you've got is a hammer, every problem starts to look like a nail. Google bought a "hammer" in Motorola -- but that doesn't mean it must use it. Google has a stellar business in software, but it really doesn't need the low-margin hardware biz. If it chooses to tread the road that Cisco did, Google will ultimately end up in the same place: saddled with an unprofitable, uncompetitive, unworkable CE business, and forced to choose between getting rid of it or letting it drag down results at the whole company.

Ultimately, Google must sell or spin off Motorola's hardware business to avoid the situation that (almost) sank Cisco. Better sooner than later. Or best of all -- immediately.

Motley Fool contributor Rich Smith does not own shares of (or short) any company mentioned above. The Motley Fool owns shares of Apple, Google, and Cisco Systems. Motley Fool newsletter services have recommended buying shares of Google, Cisco Systems, and Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple.