IP Democracy: This is Weird. Google's Growth is Cooling.

I got Google’s Q2 07 earnings release today about 20 minutes before the search giant held its analyst call and started plugging the new numbers into my spreadsheets. Once I did that, however, something didn’t look right.

Based on the Q2 07 financial data, it seemed to me that Google’s growth…is slowing. I thought to myself, “this is weird” because Google has never posted a slowing growth rate — whether measured on a seasonal basis or even absolute basis. I checked and rechecked, but, once the analysts began asking questions on Google’s call, I knew my numbers were right. No matter how you slice it, Google’s growth did cool slightly during Q2 07.

The biggest concern to investors is a drop in Google’s operating income. Although CEO Eric Schmidt has in the past promised that Google would continue to post quarterly gains in operating income growth, operating income actually dropped from Q1 07 to Q2 07, slipping by 10% from $1.22 billion to $1.1 billion.

During the earnings call, Schmidt said the cause of the decline was a too rapid growth in headcount. “We overspent on our plan in terms of headcount,” Schmidt explained. It is true that Google’s headcount soared by 74% from Q2 06 to Q207, rising from 7,942 to 13,786.

As a consequence, Google’s operating margin, the difference between its revenues and operating expenses, was the lowest it has ever been since the company went public, a modest 29%.

The rapid rise in headcount probably does explain most of the drop in operating income and margin, but revenue growth was off during the quarter too. Although Google’s revenue growth was a healthy 58% year-over-year, climbing from $2.5 billion to $3.9 billion, revenues grew by only 6% from Q1 07 to Q2 07.

Admittedly, the second quarter is always weak for Google and for Internet advertising generally, but still, that 6% sequential quarterly growth is the lowest growth rate Google has ever posted.

Don’t get me wrong. Google is a very, very healthy company and it’s amazing that Google is continuing to post growth, albeit at a slightly lowered rate, after the scorching hot two years it has had. Unless Google were capable of infinite growth, which no company is, it was inevitable that the company’s growth jets would cool.

Company execs said during the earnings call that Google’s somewhat sluggish revenue growth rates reflect the fact that Google jettisoned some inefficient advertisers and ad outlets, resulting in lower but better click-throughs. The lower-but-better click-throughs were not, however, compensated for by increases in ad rates, something that Google could adjust for in the future.

But, even if Google does twiddle with some ad price levers, don’t bank on the kind of overheated growth that Google has experienced in the past.

Posted by Cynthia Brumfield on July 19, 2007 5:45 PM to IP Democracy