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Introduction
In our first paper we argued that Google’s long-term competitive advantage stemmed from an organizational competence that focused on experimentation, innovation, and problem solving, and that the firm over time transformed these benefits into the structural advantages of economies of scale (EOS) in network effects and workforce. Since then we’ve adopted a less sanguine view on Google’s structural advantages, in particular realizing that Google’s network effects are limited, largely owing to low switching costs for consumers. Furthermore, their initial advantage, the PageRank algorithm, is now publicly known and elements are widely adopted. Also, the firm operates in a highly competitive industry. With these thoughts in mind, we have come to conclude that Google’s long term success has most likely stemmed from its organizational competence.
A recent blog post (see Appendix A) by Hal Varian, Google Chief Economist, supports our claim. In his post, titled “Our Secret Sauce”, he first debunks three main sources of structural advantage: cost side EOS (scale advantages stop benefiting fairly quickly), switching costs (fairly low for consumers), and network effect (personal utility not really affected by utility of others). Instead, he emphasizes that Google has been successful because of “learning by doing”: in other words, because Google can innovate faster than its competition. In the rest of this paper, we try to understand what this “learning” represents and why other firms cannot innovate as fast as Google.
In short, we agree that Google has been successful largely because it can innovate faster than its competitors, and we attempt to articulate the specific organizational competencies that have allowed Google to do this better than others. We believe that Google’s organizational competence is a fundamental obsession with innovation, enhanced by a culture that encourages experimentation and irreverence, all in a fun environment. In turn, this innovative and fun environment fuels their EOS in workforce, which is what allows Google to attract the talent it needs to stay successful.
What are the Core Competencies?
The core competencies of Google center around innovation. Search is an industry where obstacles to entry are few. Supply side economies of scale are limited, switching costs are negligible and network effects, minimal. Google’s primary industry, online search, has no significant barriers to entry, as we established above. Its secondary industry, advertising, is little better. An online advertiser knows exactly what the conversion rate is of its placements and if someone can provide a better rate, there is no reason for them to stay. For Google to remain ahead of its competition in these two industries, it has to be constantly pushing the edge of the envelope to get better at what they do and provide more value to their customers. As a result, they have to constantly innovate, hire the best talent possible and provide an environment where that talent can be most productive.
Google is constantly working to improve the relevancy of their search and of their products over all. Relevancy speaks to how appropriate search results are but also, more generally, to how appropriate their other applications are to their customers’ needs. Again, this necessity stems from low switching costs: Google has to provide its customers with what they want better than anyone else, otherwise those same customers can easily go elsewhere.
Google’s innovation manifests itself externally with their products but also internally with their organizational design and incentives. In order to attract and retain top talent, Google has to also provide their employees with what they want (although admittedly these employees have higher switching costs than customers). What do smart and talented employees want? They want to solve challenging problems. They want to be surrounded by a similar caliber of colleague. They want to be recognized for their contributions and have opportunities for advancement. This fun and challenging environment helps drive further innovation externally.
Two other internal competencies help develop innovation at Google: experimentation and irreverence. Google’s employees are encouraged to experiment and take risks. For instance, engineers are encouraged to spend 20% of their work time on personal projects. AdSense, GMail and GTalk all came out of 20% projects. While some value from these projects is the additional traffic and revenue they bring to Google, they also serve as role models for how employees can innovate. Those are experiments that have gone well but how does Google respond to failed attempts? Megan Smith, VP of New Business Development, when speaking at MIT Sloan, related a story of one of her failures while at Google. This failure lost millions of dollars. She took a big swing and came up short. She said that when she sat down to discuss the results of her effort with Larry and Sergey they actually thanked her for the willingness to take that chance. Rather than being punished, she was commended for the effort; Google rewarded the big swing.
In encouraging innovation and taking risks, Google embraces irreverence. Their “Do No Evil” mantra speaks to their counter-culture stance and willingness to reexamine commonly held assumptions. Employees are motivated to solving problems in the best way possible rather than simply how everyone else does it or how it has always been done. Their public offering by dutch auction is an example of this as is their ability to reinvent webmail. This irreverence no doubt also encourages employees to improve continuously on Google’s products themselves.
At the same time, innovation feeds back into the fun environment, creating a reinforcing loop where people have more fun at work because they and their coworkers are working on innovative products. In addition, an innovative and fun environment feeds into the EOS in workforce, as Google finds it easier to attract additional employees by offering them a place where they’d enjoy working. This loop is especially important considering that the EOS in the workforce is the main structural advantage that Google enjoys.
Conclusion
We conclude that the only way for Google to remain outstandingly successful is to continue to innovate faster than its competitors and invest in its EOS of workforce. However, if Google has limited structural advantages, then this implies an interesting hypothesis: Google’s ability to scale is limited by the EOS in the workforce, which may see diseconomies of scale fairly soon (20,000 employees? 50,000?). We concede that it may seem unlikely that Google will soon hit a limit on its scale, leading us to consider that Google may have other structural advantages that we have not seen. But if we are correct, then it seems plausible that Google is a firm that largely lacks structural advantages and must chiefly rely on its organizational competencies in order to continue to succeed.
However, this will likely prove to be an increasing challenge for Google, as traditionally it has been the smaller technology companies that have innovated. In which case, could another search engine that is sufficiently faster/ better than Google fairly quickly supplant the Search Giant, ending the reign of one of the fastest growing companies of our time?
Appendix A
Excerpt from “Our Secret Sauce”:
If it isn’t economies of scale, lock-in, or network effects, what is it that explains Google’s success?
The answer, at least in my opinion, is a much older economic concept called “learning by doing” that was first formalized by Nobel Laureate Kenneth Arrow back in 1962. It refers to the widely-observed phenomenon that the longer a company has been doing something, the better it gets at doing it.
Google has been searching the web for nearly 10 years, which is far longer than our major competitors. It’s not surprising that we’ve learned a lot about how to do this well. We’re constantly experimenting with new algorithms. Those that offer an improvement get rolled into the production version; the others go back to the drawing board for refinement.
So I would argue that Google really does have a better product than the competition — not because we have more or better ingredients, but because we have better recipes. And we are continuously improving those recipes precisely because we know the competition is only a click away. We can’t fall back on economies of scale, or switching costs, or network effects, to isolate us from the competition. The only thing we can do is work as hard as we can to keep our search quality better than that of the other engines.
Source: “Our Secret Sauce,” Hal Varian, Google Chief Economist.
http://googleblog.blogspot.com/2008/02/our-secret-sauce.html
Here is the thought experiment: What would happen if another company – say telepathic.org – came out with a new search engine that could read your mind and give you the exact results you wanted? In this scenario, Google has no real structural advantages (aside from maybe EOS in workforce) that would keep consumers from switching en-masse to that new site.
Google’s most important rival is Yahoo!, the incumbent in the search and advertising space when Google first launched. Yahoo! has been unable to duplicate Google’s success due to two factors: an initial lack of understanding of the value of search, and later, a cultural ability to match Google’s efforts in search. Yahoo! initially started advertising with the objective of getting more attention for their ads, without focusing as much on relevancy. Larger flashier ads would get more attention. Allowing customers to pay for search result rankings would put their results in a location that users would see more often. Google on the other hand strived to make their ad results more relevant. This served to make Google’s search better as well as their hit rate on advertisements.
When Yahoo! did realize that they had missed the boat, they did not have the culture or organizational design to match Google’s focus. While Google embraced a technocratic culture, Yahoo! adopted one centered on media, which prevented them from being as innovative. As the problem grew, bad morale started to reinforce their cultural problems, leading finally to the “Peanut Butter Manifesto” from an internal Yahoo! employee asking for massive organizational change. Yahoo! has since been unable to make the drastic changes organization-wide necessary to right the ship. They have always have pockets of excellence but they were never able to leverage that as an organization. While it is possible that Yahoo! may have been successful had it adopted a strategy congruent to its culture and media assets, it nonetheless continued to measure itself versus Google, and has repeatedly been unable to compete.
We believe that Google’s competitive advantage in both the online search and search-based advertising markets started by having better IP and underlying hardware/ software than its rivals, combined with an organizational competence that focused on experimentation, innovation, and problem solving. Over time, the firm translated these benefits and culture into structural advantages through economies of scale in network effects and workforce, which have in turn allowed the company to grow its market share year after year.
Google’s main early advantage was due simply to building a better mouse trap. Google provided more relevant search results with their, at the time, revolutionary PageRank algorithm. PageRank uses the number of documents that refer to a given result to weight that result relative to others. Developed by Larry Page and Sergey Brin, the patent actually belongs to Stanford because the work was done while they were both at Stanford, however, Google licensed the patent. By now, however, PageRank is well-known by its rivals, and cannot fully explain for Google’s success over time.
Another of Google’s key early advantages was its organizational competence that stressed experimentation and embraced technical problem solving, all the while maintaining an emphasis on fun. Google engineers are encouraged to spend one day of their workweek, or 20% of their work time, on their projects that interest them. Some of Google’s well known products, such as Gmail and Adsense, came from this 20% time.
In addition to experimentation, the Google culture also values fun, while maintaining a focus on the task at hand. Even from the beginning, the Google cofounders chose a logo that emanated playfulness and irreverence. Later on, as the company grew, it introduced lava lamps, exercise balls, even free food and dry cleaning, to help facilitate an enjoyable environment. The goal, however, was always to keep employees focused on their work and not to have them waste time with mundane chores.
What these advantages in IP and culture gave Google was a head start that it was then able to translate into the firmer structural advantages. The first structural advantage is in network effects with consumers. While Google had an early advantage in search result relevancy, its perceived lead persisted, even when Yahoo! finally narrowed that gap over time. We believe that this is because quality differences across search engines have become difficult to measure for the average consumer (instead of, say, restaurant quality), and that word-of-mouth in favor of Google is helping it maintain its lead. This advantage also helps in the advertising market, because search-based advertisers will flock to the site with the most traffic, assuming that the demographics of both sites are similar.
The second structural advantage that Google has built is economies of scale in its workforce. In 2007, Fortune named Google the number one place to work in the United States, featuring quotes from employees that explained that one of the largest draws at Google was the opportunity to work with other Googlers: “Hard-core geeks are here because there’s no place they’d rather be,” says a Google Webmaster; “You’ve got to ask yourself why these people are coming here… I think they come here to be energized by the people at Google,” says an engineer.
“In a [8/2/06] talk at Stanford University, Marissa Mayer, Google’s Vice President of Search Products and User Experience, stated that her analysis showed that half of the new product launches originated from the 20% time.” Source: Wikipedia.
The Google logo features the company letters in primary colors, save the letter “l”, which the founders wanted to color green (a secondary color) to show their irreverence. Source: “How Google Got Its Colorful Logo”, Sonia Zjawinski, Wired Magazine, 2/12/2008.
Source: Fortune Magazine. http://money.cnn.com/magazines/fortune/bestcompanies/2007/full_list/
Google is the market leader in the online search and search-based advertising markets, where it competes largely against two companies: Yahoo! (which also competes in the same industries), and Microsoft (competes in multiple industries). While Google has benefited from a rapidly growing industry (particularly in the search-based advertising space), it has in particular taken a large share of this market, especially when compared to its main rivals; in addition, its lead has only increased over time.
We used two metrics to show that Google has been outstandingly successful in both of these markets: stock price performance over time versus its rivals; and its current market share versus those same rivals. First, we compared Google’s stock price performance to that of Yahoo! and Microsoft over the past few years, as a percentage of each company’s stock price on 9/1/2004 (the first day of the first full month of Google as a public company). As you can see in figure 1 in the appendix, Google’s stock price has grown 4x since that date, while Microsoft has less than doubled, and Yahoo! has declined in value.
We also looked at Google’s market share in the online search and search-based advertising market, where we found that Google is by far the market leader in both. In online search, one recent estimate puts Google at a 69% market share in online search, with Yahoo! a distant second at 17%, which is remarkable considering Yahoo! was the market leader in search when Google was founded in 1998. In the search-based advertising, another source puts Google at a 70% market share. As you can see in figure 2 in the appendix, Google’s share in this industry has grown over time as well.
