Google redefined: the real implications of Alphabet

Last Monday, Larry Page, the CEO of Google Inc., announced in a blog post that “Google will become a wholly-owned subsidiary of Alphabet”, a newly created holding company. The news surprised the general public and many of the tech pundits shared their first impressions about the restructuring and its potential implications for Google and its shareholders. Several people reached out to me to get my feedback about the move last week. My first impression was the same as it is now, Google made a genius move that will be seen as a game changer for the company in the future.

What is Alphabet?

As Larry Page described: “Alphabet is mostly a collection of companies. The largest of which, of course, is Google. This newer Google is a bit slimmed down, with the companies that are pretty far afield of our main Internet products contained in Alphabet instead.”

In practice it means that the businesses that directly benefit from or are related to the advertising business will be under the Google subsidiary – including Google Search, Ads, Android, Apps, Google Maps, and YouTube, while all the other so called “moonshot” initiatives such as self-driving cars and the ambitious life sciences projects will be independent subsidiaries under the Alphabet holding.

The rationale – publicly announced

The aforementioned blog post argues that while Google is operating well today, the management team believes that it could be even cleaner and more accountable. This change would enable the 57 000-employee tech giant “to run things independently that aren’t very related”.

On top of this independence, Google hopes that the creation of this holding corporation will allow it to keep tremendous focus on its extraordinary opportunities. Larry Page clarifies in his post that “we are not intending for this to be a big consumer brand with related products — the whole point is that Alphabet companies should have independence and develop their own brands”.

The rationale – hidden / implied consequences

1. Building strong, independent brands with Google resources – an unparalleled value proposition for acquiring startups

In the past, Google has tried to integrate most of its acquired companies into the Google product family (except some larger acquisitions such as Nest, which operated fairly independently from day one). By announcing this holding corporation, Google not only explains the investment rationale behind its seemingly unrelated past/future acquisitions, but also creates a clear structure where it can provide high level of autonomy and independence to booming start-ups that were previously discouraged by the idea of becoming part of the online advertisement-focused giant.

The opportunity to get access to Google’s seemingly unlimited pocket (the company generated US$4.3-billion profit in the last quarter, and has around US$61-billion in cash at the moment), its talent pool, and corporate relationships combined with a very high level of independence can create an unparalleled value proposition for future acquisitions.

2. Creating nested subsidiaries as a protective measure for the future

According to the previous SEC filings, Google only has three registered subsidiaries at the moment: two general tax shelters in Ireland, and one international LLC in Delaware. It means that in the event of a legal fallout, the other, seemingly independent business units could be largely impacted. For instance, the negative outcome of a court trial about data privacy (that has been a recurring topic in Europe recently) could impact other parts of the business (e.g. Google’s life sciences projects).

The creation of these nested subsidiaries means that these potential legal fallouts or the failure of any risky moonshot projects could not impact the rest of the holding. The independent operation of these subsidiaries means that there would be no liability concern for them, and they could continue unaffected.

3. Keeping and attracting high caliber talent

Talent acquisition and retention have always been focus areas for every tech start-up in the world from the smallest garage start-ups to the largest tech giants globally. The opportunity to offer high level of independence, fancy executive titles, and the opportunity to build autonomous brands will not only be helpful with potential acquisitions but also be largely appealing to existing and potential employees.

Those highly ambitious, entrepreneurial individuals who wanted to build up a new company that is independent from Google won’t necessarily need to leave Google in the future. In certain cases, they might have the opportunity to build their dreams within the Alphabet umbrella as a subsidiary.

The new structure will likely lead to a situation where subsidiaries are fiercely competing for the available resources. This enhanced competition can result in a competitive and highly innovative environment where those employees who get tired of one subsidiary could easily transfer to another subsidiary which might have a different culture, vision, strategic focus and leadership team.

Challenges

Although, the above mentioned potential benefits far outweigh the potential risks, I think it is important to note the two largest risks I foresee associated with this corporate restructuring.

First, analysts and the market have been talking about increased transparency around the company’s financials due to its new holding structure since the announcement went public. Although, it is true that Google had announced that it would report its Q4 2015 earnings separately for 1, Google and for 2, Alphabet (non-Google) revenues, I have the impression that the expectations are exaggerated.

The problem is that Google already discloses similar details about its revenues in its earnings reports (see below), so the picture shown in the future will be very similar, only the labels will be changed (and other minor details would be added). What makes this problem even more complicated is the fact that the results shown below indicate that non-Google revenues actually declined by 3% from Q1 to Q2 in 2015, strengthening the fear that these moonshots are financial black holes.

In case this trend continues, further questions would be raised about the longevity of these moonshot projects sooner or later. To manage these investor/analyst expectations, it is possible that Alphabet will decide to split its stocks or use some other financial maneuver to enable investors to invest separately in Google, the online advertising cash cow, or in Alphabet (non-Google) with the hope of a massive return due to its ambitious moonshots. Clearly, the risk profiles of these units are very distinct, so splitting the two could dismiss the increasing pressure of Wall Street.

Q2 2015 Financials – Google

Second, Google has been famous for building a unique corporate culture that was embodied in its motto “Don’t be evil”. The new holding structure will create the opportunity for subsidiaries to co-exist with Google under the Alphabet holding, even if the culture, compensation, incentives, expansion strategy or any other aspect of these businesses is fundamentally different from that of Google.

The leadership team of Alphabet will need to clearly define the guidelines about how to manage cultural conflicts, how to allocate financial and human resources, especially in those cases when start-ups are acquired and then integrated into Alphabet as an independent subsidiary. Will it be easy? Definitely not. However, by creating the structure around its next phase of corporate development, Google has made an important step to guarantee its role as the most important technology company of the coming decades…

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This article by Daniel Petz originally appeared on Dpetz and is republished with permission.