Market turns on bloated Google

The internet giant's revenues are up, but costs are up even more, and investors are not happy. Nick Clark reports

Google's newly installed chief executive Larry Page was beaming on Thursday night as he unveiled a "tremendous quarter" for the search engine giant.

His enthusiasm was not matched by the market despite revenues soaring 27 per cent; the only rise the analysts wanted to talk about was in the company's costs. While some believe the subsequent 7 per cent slump in its share price was overblown, others said the quarter marked a significant moment in the Californian company's development.

After the bell on Thursday night, Google unveiled revenue of $8.5bn for the first three months of the year, up from $6.7bn a year earlier. Profits were up a fifth to $2.8bn. Mr Page said: "We're really excited about that, and I think it shows the strength of our business and the continuing growth in the tech industry." Ad revenues actually beat market expectations, but the share price suffered as the company said expenses had risen more than a third to $5.7bn as staff costs soared alongside investment in new initiatives.

Adrian Drury, the lead analyst at Ovum, said: "The costs are one of Google's big problems, and in a way reflects that it has gone from being the hot company, to just one of a number of hot companies. It is now a member of the old guard and that is a tough transition to go through." He said the results showed a growing but "structurally more competitive market".

Google now employs 26,316 staff, up from 24,400 just three months earlier. And it is continuing to expand. It announced in January that 2011 would be the biggest hiring year in its history, even beating the 6,000 brought on board in 2007. The group also announced a 10 per cent salary hike for its employees in the winter. Chief financial officer Patrick Pichette said: "As you can see through our expenses, they reflect, for the first time, the full impact of the compensation changes we announced in the fourth quarter," adding it was a "one-time step change".

Mr Drury said: "In Google's market you cannot afford for the innovation cycle to slow. It needs to expand and also needs to bring in the strongest engineers."

He added that Google now faced strong competition from rivals such as Facebook and LinkedInto attractengineers.

The costs have also increased because of the rising investment in real estate needed to house the new staff. The financial director also added legal fees were higher in the first quarter.

Google has also increased its marketing spending, and said it does not expect to slow that drive. The investment in other expenses including data centres, as well as content acquisition and credit card processing charges also rose.

Mr Pichette talked of the company's "accelerating growth trajectory" adding: "We had the business confidence to invest heavily in the next phase of innovation and revenue generation. Our product innovation over the past 18 months has been nothing short of extraordinary". He pointed to the growth of the Android operating system, the development of the Chrome browser and operating system, and the drive into mobile search. "From an expense point of view, we're taking some bold steps but always with good strategic rationale in mind and discipline in mind," Mr Pichette said.

Whit Andrews, an analyst at Gartner, said the fears over costs were overblown. "Anything short of amazing results was always going to disappoint. Investors are also nervous around a change of management." However, he added that such a significant drop in the share price would "always concern a chief executive".

Mr Page, who was reappointed chief executive earlier this month, said during the results call on Thursday night: "Now I'm very excited about Google and our momentum and very, very optimistic about our future."

Not everyone is quite so sure. Mr Drury of Ovum said: "The costs will continue to be an issue for Google. It has to demonstrate it is innovating and make bets in new markets as well as holding market share." The analyst added: "Inflation in its wage bill is going to persist and it will need some of its bets in video and display advertising to start paying out to stabilise its operating margin."

Good life at the Googleplex

As the results showed, Google invests heavily in bringing in highly skilled employees. Once they walk through the door it invests further to make sure they do not want to leave.

This approach is seen in the extraordinary culture of perks the company offers. Google employees do not have to pay for food in the canteen or for water and fizzy drinks. They get free use of a gym, and in the US employees can have their hair cut on site or enjoy a subsidised massage, while any wardrobe malfunctions are handled by the laundry services, with dry cleaning on site.

Google also hopes to keep employees occupied during their downtime. They can knock up on the table tennis table or play pool, table football or a range of video games. This array of services has not met with universal acclaim, however, and the former eBay chief executive Meg Whitman said there was a danger in creating a culture of perks because "it can be difficult to adjust people's expectations once they have got used to certain indulgences".