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The CFO and R&D at Google

Bloomberg just published a fascinating, in-depth, behind-the-scenes profile of the impact of CFO Ruth Porat’s push for financial discipline and focus at Alphabet (the company formerly known as Google).

In the past, Google has grown so quickly in terms of revenues and profits that it’s been able make do with just a high level accounting and reporting of its numbers to outside investors. However, Alphabet / Google is now so large and complex beyond its core business of online advertising that it is transitioning towards a more traditional, conglomerate style of holding company structure á la GE in order to both provide increased transparency to Wall Street as well as to drive much need financial rigor inside the vast company. This resonates with our perspective given our experience providing outsourced CFO service to a wide variety of both tech and non-tech companies here in the San Francisco Bay Area.

In particular, Google X (aka the “moonshot factory”), where huge investments and losses are being racked up in the pursuit of breakthrough, “flying saucer” type of technologies. The profile highlights the messiness and tensions in trying to instill more business-like discipline and accountability into an inherently difficult type of strategy.

Astro Teller, head of Google X, gave a Ted talk earlier in 2016 where he admitted to this tension:

“I have a secret for you,” he began, with a self-assured smile. “The moonshot factory is a messy place.”

Already for Alphabet, there have been a number of high-profile failures from Google X. These include Google Glass, robots, fiber networks, and home networks. The cost of these moonshot investments is piling up. In 2015, these “Other Bets” (to use Google parlance) lost approximately $3.6 billion which about 2X worse than the previous year.

The chief architect of imposing the new company structure and discipline is, to no one’s surprise, Ruth Porat. She became Google’s new CFO in 2015. Here’s a great tidbit from the article about her role as a CFO and working with the CEO (Larry Page) as a true, internal business partner:

“She joined Google in May 2015 with a mandate to bring discipline and focus to a company so awash in cash that it never needed much of either. She instituted rigorous budgeting and, according to people familiar with Alphabet’s operations, forced the Other Bets to begin paying for the shared Google services they used. Projects hatched with ambiguous timelines of 10 or more years in some cases had to show a path to profit in half the time.”

For what it’s worth, Alphabet’s investors are pleased and attribute much of the increase in the company’s market value to the CFO providing better financial information and transparency. Wall Street feels more comfortable that Alphabet is finally adopting the more standard financial controls and reporting that are standard at other large, public companies (and not as common at startups and private companies).

As a part of the more detailed financial information, it’s become clear that Google’s ad business continues to dominate by accounting for 89% of Alphabet’s total revenue ($76 billion). Profits have grown to a staggering $5 billion in the most recent quarter.

“As one ex-executive puts it, ‘No one wants to face the reality that this is an advertising company with a bunch of hobbies.’”

In another recent, high profile failure for Google X, Google acquire the hot startup Nest for $3.2 billion a couple of years ago. The vision at that time was to use the Nest acquisition as the foundation and platform for a broad, home-focused hardware division. Supposedly, the division was given great flexibility in its product strategy as well as a budget that would allow it to lose $500 million each year for the next five years.

In Silicon Valley as well as among Alphabet’s employees, the new focus on financial discipline is being viewed somewhat cautiously. As one prominent VC at Kleiner Perkins observes:

“I just hope that Larry and Sergey keep financial discipline from swallowing innovation.”

In the short-term, these fears of financial focus hurting investments in technology innovation appear to be misplaced. In the most recent quarter, the company spent $3.6 billion on R&D, which is an increase of 11% versus the previous year.

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