Thursday, March 8, 2007

Eric Schmidt Succumbs to Temptation?

Among are many temptations facing big company CEOs are the twin lures of “related” diversification and vertical integration. Both can make economic sense, but they are often pursued for the wrong reasons. Latest rumors suggest that Google CEO Eric Schmidt is succumbing to the latter temptation.

Diversification allows a firm to reuse capabilities — whether R&D and distribution — for other products. HP found a way to make inkjet printers (and repackage laser engines) to the degree that peripheral profits (and market share) dwarf anything it does in PCs. On the other hand, IBM, the biggest computer company in the world found that its sales channel (and cost structure) couldn’t efficiently sell PCs, and so it dumped them after years of losses.

Vertical integration makes sense if you can’t buy inputs (or sell outputs) on the open market. If a company makes mobile phones, perhaps it should make the components or software that go into those phones. Apple created its own retail distribution channel because the existing one was ignoring a platform with 3% market share, but Palm tried the same thing and failed.

When Schmidt got his C.S. Ph.D. from Berkeley, as far as I know he never sat in one of Oliver Williamson’s courses about industrial organization. Maybe that explains rumors that Google is developing its own mobile phone (complete with pictures).

In web services, vertical integration is tricky. If Google starts selling its own client devices, it will be tempted to favor its own client — pissing off makers of rival products and owners of these products. Then owners of Nokia or Apple phones will find Yahoo’s mobile services more attractive than Google’s.

Of course, big company CEOs need revenue and earnings growth to prop up the stock price (and thus incentive compensation). When the core business stops growing, you need to find something else. Google can’t increase its market share in search, so it has to enter new markets.

[GoogleMan]Perhaps France will finally gain meaningful allies in its Quixotic fight against Google’s PacMan-like quest for total world domination.

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