CNBC: Google’s Alphabet Move Was Brilliant

From CNBC, posted August 19, 2015

Google‘s plan to reorganize into a holding company called Alphabet is as creative as the company itself.

Like all publicly-held companies, Google faces dual challenges of sustaining its growth through innovation and meeting the expectations of its shareholders. The ever-increasing pressures to deliver short-term results while continuing to make big bets on high-risk, high-gain ventures is a conundrum, even for high-flying Google with its dual classes of stock.

With nearly $70 billion in annual revenue, a market capitalization of more than $450 billion, and a stock trading at 31 times its price/earnings ratio, it will take very large bets on major breakthroughs to sustain Google’s growth. Those bets don’t turn into winners without enormous investment and the willingness to take big risks. Meanwhile, Google’s investors are clamoring for greater transparency, which can lead to pressure to cut back on uncertain investments or create premature visibility. Google’s leaders have the wisdom to know that size and creativity are inversely correlated, as witnessed so vividly in the demise of Hewlett-Packard‘s innovation machine. Thus, they are breaking the company into a collection of innovative organizations — some very large, some small — that provides their leaders the freedom to innovate without near-term financial constraints.

Some pundits claim that greater visibility will stifle Google’s innovations, which they term “unprofitable experiments.” In reality, all research projects are “losers” until they succeed in the marketplace. These critics don’t seem to understand the determination of Larry Page and his cohort of brilliant leaders to transform the world through innovation.

Nevertheless, I won’t be surprised to see an activist investor like Dan Loeb or Nelson Peltz call for breaking up Alphabet in a few years into cash-generating Google and growth-generating Alphabet. Their inability to understand the integration of these two differentiated strategies for long-term shareholder value creation — the strategy we followed at Medtronic — never ceases to amaze me.

Other writers are comparing Alphabet to Warren Buffett’s Berkshire-Hathaway. Other than both organizations being led by brilliant people, this comparison doesn’t hold water. Buffett’s genius is buying up traditional low-tech companies and running them well. He openly eschews innovation. Google is all about innovation.

Peter Sims, who co-authored “True North” with me, had a far better comparison: Today’s high-tech leaders like AppleFacebookAmazon, and Uber are platforms on which to build profitable business extensions off a solid core structure. On the other hand, Alphabet is a platform of platforms. While these platforms may be run independently in the near-term, I suspect that ultimately they will be integrated through the genius of Google’s leaders.

The most significant aspect of Google’s reinvention as Alphabet lies in its capacity to recruit and retain amazing creative talent, something most innovative companies have been unable to do. Just glance at Google’s remarkable stable of innovation leaders:

These aren’t just names on the Alphabet organization chart. All of them are superstar innovators with many breakthroughs to their credit. Is there any other organization with so many innovation leaders? Under Alphabet, they can pursue their breakthrough ideas without the day-to-day pressures of quarterly earnings.

In the world of high tech, long-term investors would be wise to ignore the roller-coaster short-term swings in stock price, and bet on the leadership of the companies. In reality, success in high-tech investing is much more closely correlated with innovation leadership than it is with quarterly results.

Having brilliant innovation leaders is what makes Google, Apple and Facebook so successful, and causes TwitterBlackberry and Nokia to fail. For all of its talent, Microsoft failed to innovate from 2000-2014 not because it lacked innovators, but innovation leaders. With former CEO Steve Ballmer finally moving to the LA Clippers, new CEO Satya Nadella’s challenge is to find the leaders who can reignite Microsoft innovation capabilities.

Eric Schmidt and Larry Page understand this phenomenon and have moved aggressively to transform Google’s organization structure. Alphabet will enable Google to sustain its innovative character and retain its growing stable of innovation leaders.