The Google backlash begins

The Internet search giant is having a rough week -- and not just because it missed Wall Street's profit forecast. Here are four steps the company should take now to stem the fallout.

By Chris Taylor, Business 2.0 Magazine senior editor

(Business 2.0 Magazine) -- Thursday was hardly the best day in Google's three years as a public company.

First, Congress announced it would hold hearings to examine the company's proposed acquisition of fellow online ad firm DoubleClick, a deal the Federal Trade Commission is already scrutinizing.

Google CEO Schmidt admitted Thursday that the company's hiring binge hurt second-quarter profits.

Then a German conglomerate including Bertelsmann and SAP (Charts) scored a $166 million grant from the German government to build a search engine -- a potential European Google-killer.

To cap it all, Google (Charts, Fortune 500) missed earnings estimates by a hair's-breadth after the market close. Its 2007 second-quarter revenue rose an astonishing 58 percent -- yet analysts had set the bar even higher, at 60 percent.

Fundamentally, the company is still the strongest thing going on the Internet, but try telling that to the hordes of after-hours traders who drove the stock down more than 7 percent late Thursday.

And the drubbing continued Friday. Google shares finished the regular trading sessions down more than 5 percent, to $520.12, amid a broader market selloff marked in part by investor worries over disappointing earnings from Google, Caterpillar (Charts, Fortune 500) and Ericsson (Charts).

From the look of things, the Google backlash has begun.

It's hard to grow a company this big this fast without attracting regulators, doubters and deep-pocketed competitors. Google may have an unassailable lead in search and online ad sales, but a shift in public perception, and the deflating stock price that would result, could quickly become the company's Achilles heel.

Here's what Google CEO Eric Schmidt and crew need to do in the short run to stay the course:

1) Don't grow out of control.

Google missed its estimates partly due to its recent hiring binge. At the end of last year, Google had about 10,000 employees; the company payroll now counts around 13,000. That's all well and good while you're growing, but that many employees could quickly become a major drain on resources when there's a downturn in the online ad market.

Google's human resources needs to be reined in, and the boss knows it. "We overspent in the area of headcount," Schmidt acknowledged during Thursday's earnings call. "We hired a little faster than we had planned. The people we brought in are good, so we decided it wasn't a mistake, but we'll watch it closely in future."

So will investors.

2) Fight for the DoubleClick deal.

It's been four months since Google offered $3.1 billion -- its largest acquisition yet -- for DoubleClick, which specializes in targeted banner ads (as opposed to Google's targeted text ads). The prospective combination made rivals and regulators uneasy, and now subcommittees in both the House and the Senate are set to issue subpoenas to Google executives.

Schmidt needs to overcome fears with a convincing argument that competition is alive and well in the online ad world: both Microsoft (Charts, Fortune 500) and Yahoo (Charts, Fortune 500) have made advertising-related buys in recent months. If Google and DoubleClick merged, their market share would still be less than 50 percent.

3) Show us the money from YouTube.

Google paid $1.65 billion for the world's most popular online video site last year. Despite a lot of talk at the time about monetizing YouTube -- and sharing revenue with users -- Google has just taken its first tentative step in that direction: It's now inserting unobtrusive Flash-based ads at the bottom of the screen in some videos.

Will it be enough to justify the price tag, or will advertisers be skittish about the threat of copyright lawsuits on YouTube content? The $1 billion Viacom lawsuit isn't going away any time soon, and Schmidt plans to fight it tooth and nail (last week he told reporters that Viacom (Charts) was "built on lawsuits").

Bottom line: the YouTube integration is very much a work in progress, and investors' patience is wearing thin. Stay tuned.

4) Find another cash cow.

Sure, Google is profiting handily from what looks like a bottomless pit of online ad dollars. Yet, at some point -- maybe not this year, maybe not next, but sooner rather than later -- this market will mature.

And then what?

None of the other items on co-founder Larry Page's famous list of Google's top 100 projects are generating any significant revenue yet. The company is making a play for enterprise customers, and last week announced it would be buying Postini, the corporate e-mail security company, for $625 million. Google's first step? Announcing that the subscription service would soon offer a free version, with ads.

If the search giant can't find new ways to spin money soon, more lousy days may be ahead.  Top of page

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