Debating Alphabet Inc.
In the past few years I've written quite a bit on technology stocks and why value investors should embrace tech stocks as opposed to avoid them at all cost. Of all the U.S. tech companies, I've owned only Alphabet (NASDAQ:GOOGL). I have never sold a share and still am a shareholder of the company. For the few years that I've held Alphabet's shares, I've visited the campus many times, had a number of meaningful conversations with Googlers, and experienced a few ups and downs with the company. But my views of Alphabet have evolved. (Below I'll use the name Google instead of Alphabet because Google is the most important business and "Googlers" sounds much better than "Alphabetters.")
Although I had been familiar with Google's products since the debut of Google search and Gmail in the early years of the 21st century, as a value investor, I've shunned analyzing Google until the middle of this decade. I can't remember exactly when, but a conversation with a Googler friend changed my attitudes forever. As we were discussing Google's business and culture, he asked me what I use for search and personal email. My response was of course Google and Gmail. He then asked me how many of my friends use Bing and Hotmail as their primary search engine and primary personal email tools. I said I can't recall anyone.
Why is that? He then explained to me that there is no marginal benefit from switching to a competitor's search product but the marginal cost can be high. That's when it suddenly dawned on me that Google's products are naturally monopolistic. As our time becomes more fragmented and precious in the digital age, our brain will inevitably help us save some energy by directing us to the most efficient digital tools. We all use search engines and emails multiple times a day. Because of the frequency and utility of these products, an even 1% difference in quality is enough for the No. 1 player to dominate the entire market. Essentially we've formed mini habits that are hard to be broken. We know we'll get better search results on Google and better email services with Gmail. The switch cost gets higher over time.
The Googler's job is to develop the best and most efficient products for us so that we'll have the best user experiences, so to speak. But you need a culture to attract and retain the best engineers to develop superior products. So culture is enormously important. What Google built is the best culture for engineers - smart, intelligent, rational open-minded, nerdy, fun, embracing of mistakes and so forth. Google also offered the best pay package. I was astonished when I learned the win-rate of Google was almost 100% when candidates have competing offers.
This engineer-centric culture, in the early years, was critical because it was at the core of the reinforcing feedback loop.
In the next year or so, I got to know quite a few more Googlers. They are all super smart, rational and open-minded high-caliber engineers. In some ways, my decision to invest in the company was a bet on the talents Googlers have.
Google still has that culture, but recent developments have made me rethink whether the circumstances have changed.
First, the best days of the search business have probably passed. While YouTube's advertising business is still growing rapidly, the traditional search ads business has slowed down. Other advertising platforms such as the one offered by Facebook (NASDAQ:FB) have taken share from Google. This is okay if the search ads Googlers have made include a sense of urgency and insecurity. But from my dialogue with Googlers and from visiting the campus, I think most Googlers are still in a complacent mood. The search ads group certainly is overstaffed at this point. But Google rarely fires its engineers. Like Charlie Munger (Trades, Portfolio) said, it's like a kindergarten. I'm worried that the welfare might have spoiled the engineers and brought too much sloth and contentment.
Second, from speaking to multiple Googlers in the Cloud business, I've learned that sometimes Googlers introduced unnecessary complexity into the enterprise cloud products, which makes them not user-friendly to the end engineers. And sometimes there's a sense of arrogance and intellectual superiority in the design of the products - "We have the most technically superior products and it's your problem to learn how to use them." Obviously Google executives know about the issue - the hiring of senior executives from Oracle (NYSE:ORCL) clearly is a sign of acknowledging the problem.
Third, bureaucracy has grown within the company. This is probably inevitable as an organization grows its employee base due to Parkinson's Law and the Peter Principle. I don't have any unrealistic expectations.
In sum, Google's engineer-centric culture has been crucial in establishing a monopoly power in the search ads business. What I'm debating presently is whether this engineer-centric culture is now working against the company as the circumstances change and whether CEO Sundar Pichai can break the second law of thermodynamics for Google. For now, I still have faith in the company and will hold on to my Alphabet shares.
Disclosure: Long Alphabet (NASDAQ:GOOGL).
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This article first appeared on GuruFocus.
