• by Mark Simon , July 23, 2007

Even after a 7% stock drop, Google still looks healthy. Q2 didn't meet investor hopes, but Google still managed to grow a tremendous 58% over last year -- and analysts predict Google will take in roughly 30% of U.S. online ad revenue by year's end. In the words of Cantor Fitzgerald's Derek Brown: "It is hard to look at [Google's]... revenue growth and have conviction that they are hitting a wall."

But there's still cause for concern. By its own admission, Google is making less net revenue because it's spending more. But when you follow Google's spending patterns, you see that more than just putting money into investments, the company is putting money into things it may not understand. This is a bad habit for the growing giant to settle into, and it's why Google may need to think differently as it matures into a new kind of leader in the corporate landscape.

Spending on Employees

On last week's earnings call, to explain Google's 85% year-over-year rise in Q2 operating expenses, CEO Eric Schmidt pointed to Google's huge hiring growth-Google had pulled in 1,500 new workers by June. Explaining why overspending on new employees was OK, Schimdt added: "The kind of people we brought in are so good, we are happy we did this."

Schmidt may be right to be happy. The right talent costs money, and over the long term, a good hire will pay for itself. But at the same time, it's impossible to know how new employees will work out, or where they'll fit in a growing organization. Which is why "exceeding the head count" could either be a brilliant move or a poor investment.

Either way, overspending on employees shows Google's readiness to gamble on what looks to be a good opportunity. By itself, of course, hiring people -- even many people -- doesn't look like the makings of a spending spree. But the hiring surge needs to be viewed in the context of Google's acquisitions.

Spending on Acquisitions

When considering Google acquisitions, YouTube is an instructive case. Google purchased YouTube for $1.6B, with the plan to turn the video giant's eyeball share into cash. Google would just need to provide the right ad model.

But more than half a year later, that ad model still seems far away. Omid Kordestani, Google's senior vice president of global sales, said on last week's earnings call that Google "still needs to prove [YouTube] to advertisers and publishers before we scale it," and that the Google team was on the case. How Google plans to "prove" YouTube was left unanswered. Meanwhile, YouTube hasbrought Google a $1B lawsuit from Viacom.

The problems from YouTube are important to keep in mind as 2007 turns into a bumper year for Google acquisitions. While Google made nine major acquisitions in 2006, Google has already acquired 11 companies in 2007 -- and it's only July. Google is further awaiting approval on the $3.1B DoubleClick deal, and a $625M deal to buy Postini.

Between over-hiring and acquiring heavily, Google is clearly comfortable with paying high sums to leap into uncharted waters. But YouTube raises real questions as to how well Google understands a new territory before it buys into it.

Spending Away Trust

Much has been said about how Google may be risking losing users' trust, butit's a point worth returning to here. Google is masterful at the business of search--both in terms of delivering quality results, and in monetizing search queries. But Google is hardly the only search engine around, or even the only excellent one. And so Google hasn't won search on technical ability alone. Much of Google's huge market share comes down to branding: People love the quirky, helpful upstart with the corporate mantra of "Don't be Evil."

But that image is in jeopardy as Google moves up in the corporate oligarchy. Privacy advocates are concerned over Google's use of information. The FTC wonders if GoogleClick will become an unfair monopoly. Copyright holders fear Google's liberal interpretations of intellectual property laws. Even Congress is getting concerned.

Google has been taking bold moves, and has been banking on the public goodwill to stand by it. If Google loses its lovable image, its users could easily defect. Again, it looks like Google has charted out new territory without considering all the costs---and it could get hurt.

Does Google know what it's doing? Or is it breathless on newfound power, buying first and facing the consequences later? We'll have to wait and see. Either way, Google might do well to reassess its spending approach for Q3.