Google, China, and the root of all evil

Today, Google shares have fallen some 9% after reporting earnings of $1.22 per fully diluted share -- a slight surprise to the Wall Street analyst community, which had been looking for $1.76. Of mildly cold comfort to the analyst community -- and to your host, who was net long -- was that excluding options expenses and charitable donations, the figure would have been $1.54, a mere 12.5% shortfall instead of the actual 31% that it represented.

In apparently separate news, Google came under heavy criticism last week for its decision to comply with Chinese government censorship in order to launch a local edition of their otherwise-dominant search engine. When this latter story broke, it was on the heels of news that Google had just refused to comply with a U.S. Department of Justice request for records -- sans personally-identifying data -- of pornography-related search terms. At the time, these stories were generally perceived to illustrate hypocrisy, or at least inconsistency, in Google's claims to "do no evil", a story exposed in these pages previously here and here.  Radagast wrote about it then as well, and wondered what your host might have to say about it. The earnings release does much, however, to clear up the confusion about Google's business practices.

Let's start with two observations about Google's business in general:

1) Google is a private company which provides an enormously, mind-bubblingly useful service for no cost to end users. The terms on which they provide that free service are completely up to them. So long as Google's paying customers believe that Google's management of their service provides them a better return on investment than any other online advertising medium, there is no reason for them to listen to anyone else about how to run their service. And this is how it should be so long as "anyone else" doesn't own a stake in the company, buy advertising services from them, or work for it. People who attempt to define themselves in as "stakeholders" when they are not in one of these roles lack the credibility of someone whose livelihood really does depend on the company's operation.

2) It is an utter fantasy to expect that businessmen making rational calculations about profit-maximizing behavior will voluntarily cede markets to other businessmen, especially when they know that no net gain in ethical behavior will occur as a result. Google's staying out of the Chinese market does not mean that Baidu will behave in a more honorable manner.

This brings us to the fundamental tension in Google's business practices, a tendency for management to act as though they are aware of these issues, while behaving publicly as though they are not. The leadership of the company -- inventors Larry Page and Sergey Brin, and serial technology company CEO Eric Schmidt -- is comprised of two individuals with a disturbingly immature, college-student-sloganeering view of the world, and a man who has worked hard to be as distrusted on Wall Street as he is respected within the technical environments he works in. Don't take SC's word for it, take Jim Cramer's (subscription required):

Google is one of the worst-run companies when it comes to telling its story and dealing with Wall Street. That's in part because of Eric Schmidt, who is not well-liked on Wall Street.

It is hard to be certain which of these three individuals bears the most responsibility for Google's general refusal to disclose material information except at quarterly earnings calls, but suffice it to say that Google's management team has established an arrogant attitude towards the outside public, shareholders and disinterested observers alike, whereby they will frequently make sophomoric moralistic pronouncements about their business, while providing little solid basis for estimating their ability to run it in accordance with their principles. To give just one example of the immature outlook of Messrs. Page and Brin, consider their recent purchase of a jet for the company (admittedly, funded through their private wealth, and not from corporate coffers). Rather than simply saying, "Look, executives like to one-up each other, and buying a Boeing 767 trumps all those other billionaires with their little Gulfstreams", Larry Page justifies it in terms of occasional charitable endeavors, and says of his purchase "I think that can only be good for the world." Google's leadership simply cannot perceive that some of their acts are merely morally neutral, the same as buying a newspaper, because they are so certain of the basic goodness of their intentions.

Having made these points, let's turn to a recent Editor and Publisher editorial by Thomas Lipscomb on the subject of Google's deal with the Chinese government:

Some years ago, as the Soviet Union was headed for its demise, a Moscow Book Fair was announced and publishers in the United States and throughout the world flocked to gain access to a huge potential new market. The Soviets promised an open market at the Fair to display what publishers felt were their best books most suited to the market. But as soon as the Fair opened, Soviet police moved in on publishers and confiscated books they felt might "feed agitation."

Other publishers, fearing this kind of action, had already self-censored the books they displayed or quickly removed them on the spot. Times Books, the general book publisher owned by the New York Times Company, immediately withdrew from the Fair, arguing that it was difficult to maintain First Amendment standards in the United States while conceding them elsewhere. A lively debate ensued, and the Moscow Book Fair was seriously diminished as a marketplace thereafter.

Reserved to the biographical note at the end of the piece is the fact that Mr. Lipscomb was the head of Times Books who made the decision to withdraw.

Mr. Lipscomb's position -- that sometimes, defending the conditions that make your business possible outweighs short-term profit goals -- is the crux of the current controversy. Google's behavior in China does not wholly ignore that idea -- when they provide censored searches, they indicate that censorship has occurred through a notice on the results pages provided to the user. Google's executives also recognize that as they introduce services which result in ever-greater quantities of personal data being stored on their servers, their business is dependent on assuring user confidentiality, a point made ably by John Battelle. As a result of this, they are not offering Gmail or Blogger service locally to Chinese users. These steps contrast admirably with those taken by Yahoo! and Microsoft in launching services, as SC has noted before. And even those comapnies may be regretting the totality of their knuckling under to Communist dictatorship. Just today, Microsoft has changed their own blog censorship policies in response to Western outrage over their behavior in a case involving a blogger working for the New York Times.

The problem is that Google's management is aware of their responsibility to shareholders to grow the company, aware of the problems created by censoring their search results, and yet utterly unwilling to deal with the public relations disaster that occurs by their inability to reconcile hard decisions with their public pronouncements.  Google may actually have taken the most honorable approach of any company seeking to do business in China -- without any Blogger information to turn over to the government, we won't be hearing about journalists jailed because the company compromised their privacy rights, like we did with Yahoo!. They may have taken the most principled position in the U.S. pornography case -- while SC believes the government is acting within their rights in the present circumstance, the precedent of turning over records in the absence of clear wiretapping-type laws that deal with search data is a bad one to set.

Having considered all these conflicting pressures, we can at last be clear about the true purpose of the controversies over Google's apparently inconsistent behavior in the last two weeks. Messrs. Brin, Page, and Schmidt knew well before yesterday that their earnings report would fall shockingly short of expectations, even taking into account the various charitable deductions and option expenses (the latter of which many people are inexplicably opposed to calculating corporate earnings). Therefore, they needed to demonstrate clearly to investors that they were working hard on not being left behind in the Chinese market, a fact evidenced by China and "international markets" being mentioned in ratings reiterations from stock analysts today. The simultaneous announcements of expansion into China with compromised data and an unwillingness to compromise data at home were meant to indicate that while Google is doing everything they can to grow their revenue base, they do not intend to compromise their existing sources of revenue. Pornography is a significant part of their American revenue base (although no exact figures are available, some research estimates say that Google is responsible for over half of all search referrals, and somewhere around 25 percent of all searches -- not just on Google -- are for pornogaphy; SC notes that he has not found a primary source for this latter figure, just several references to it), and so "do no evil" aside, investors can be absolutely certain that Google is moving to protect that revenue. Because Google's executives will not simply acknowledge that their business is a business first, and a charity/public defender second, these announcements come off as the products of a singularly capricious arrogance, and we are left to sift through the fine print to see that perhaps they are doing less evil than things appear at first glance.

But then SC thinks of this experiment suggested by Jonah Goldberg, contrasting image search results for "Tiananmen" from Google's U.S. and Chinese sites, and wonders if even the controls they have put in place really represent change.

At the time of publication, SC was net long Google. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. SC cannot provide investment advice or recommendations, and the preceding article shall not be construed as a solicitation for the purchase or sale of any mentioned security.

Comments

[ZHchinafile]

I have a small blog called CHINA FILE at blogger; it chronicles just some of the anti-American and tyrranical things Communist China does. It was blocked by Blogger(Google) for weeks. You could not bring it up on Blogger search until two days ago, while when it was first established it came up without exception.

[The Tensor]

I didn't understand that middle part, but you're saying I should buy shares of Google stock, right?