Innovation, Google & Employee Retention

[Author's note: A new article on this blog regarding Google employee retention is also available.)

A recent Wall Street Journal article - "Start-Ups Make Inroads
With Google's Work Force" has many people in the technology and business community clamoring with regard to Google’s innovation and employee retention challenges.

Google has long been a source of personal interest, stretching back to 2000 when I was first introduced to the website by a business school professor. What most intrigues me about Google is its culture of innovation and development. I organized a tour of Google for an executive MBA cohort from Kyiv-Mohila Business School in 2005 and obtained brief exposure to its corporate life.

In reading the WSJ article, I began to think about Google’s innovation strategy from an economic point of view, and found the following “Equilibrium Innovation” model in a textbook sitting on shelf (stick with it - it's not as complicated as it looks!):



Where:

CoI = Cost of Innovation
PVI = Present Value of Innovation
L_R&D = Amount of Resources devoted to R&D
g = Innovations/year
B = Amount of resources needed to create an innovation

(Source: Van Den Berg, Hendrick. “Economic Growth and Development,” c. 2001, McGraw-Hill. Page 216.)

PVI is a function of the monopoly profit (π), discount rate (r), and L_R&D/B.

CoI is a function of the price of resources (w) and the amount of resources needed to produce an innovation (B).

This graphical model shows that as more resources are dedicated to R&D, the “Cost of Innovation” increases and the Present Value of Innovation decreases. In economic terms, the CoI curve is the “marginal cost curve” and the PVI curve is the “marginal benefit curve.”

So how does this relate to Google and its innovation strategy?

An article printed in the July 10, 2006 edition of BusinessWeek , considers the success rate of Google’s innovations – citing that the success rate of new products at Google is below planned corporate levels.

According to their 2006 annual report, Google anticipates “that research and development expenses will increase in dollar amount and may increase as a percentage of revenues in 2007 . . . because we expect to hire more research and development personnel and build the infrastructure required to support the development of new, and improve existing, products and services.”

In order to maintain the innovation growth rates of previous years, say from 2002 – 2004, Google is looking at a HUGE expenditure if it considers this investment in R&D in a per employee basis. Employee counts at Google have risen tremendously in the past 3-4 years, from approximately 1500 employees in 2003, to 3000 in 2004, to 7000 in 2005, to 11,000 in 2006.

Going back to our model and considering the R&D and infrastructure costs on a per employee basis, this equates to a potentially substantial rise in the Cost of Innovation (CoI), especially as labor markets remain competitive during the current period of economic growth – leading to a higher price of resources (w) and the increasing amount of resources necessary to create an innovation (B). As CoI shifts upwards, the number of innovations will ultimately decrease.

Regarding PVI, increases in B will contribute to a lower PVI. Additionally, as innovation occurs more rapidly, the monopoly profit that Google will receive for their innovation will decrease because new innovations will overtake the usefulness of current innovations (Joseph Schumpeter and “creative destruction”). These factors will shift the PVI curve downward, further decreasing the number of innovations produced.

If we couple two factors:

1. The effects of shifts in CoI and PVI due to higher overall innovation costs; and
2. The appearance of Google’s “shotgun” approach to innovation

the net result is slower innovation and development within the company.

If Google has had a penchant for hiring those unique individuals that want to innovate, incubate, and develop new ideas but their internal structure inhibits employees from doing so, this may explain the reported move of employees to new companies and start-ups.

Breeding Partnerships

Last week, I traveled to Canada (including Winnipeg, Regina, and Saskatoon) with a representative from the Ministry of Agriculture of Kazakhstan to continue work on a current project we are undertaking. The representative is the director of an agricultural research facility in Astana, and the goal of the trip to parts north was to discover possible partnerships that may exist between Canadian agricultural organizations and universities, and those in Kazakhstan.

Working on projects such as this, it is always amazing to me what can be accomplished in a single meeting between two interested parties with legitimate stakeholder opportunities in a newly developing project. In this case, Canada is a global leader in grain development, processing, and milling technologies (among many other agricultural sectors).

One example is a meeting with held yesterday at the Western Canadian Farm Show in Regina, Saskatchewan. We met with a representative from the University of Saskatchewan that is responsible for developing international partnerships and liaisons. After discussing the goal of the project in Kazakhstan and the desire to establish connections with their research institutes, we were able to verbally agree to sign a “Letter of Intent” to begin working together that will be signed in the upcoming weeks. For the University, this is an opportunity to transfer know-how and technology to an important international market, and for the Kazakh counterparts, this is an opportunity to expedite the development of their agricultural research facility in Astana.

The meeting was established through significant planning and research from our end on behalf of the ministry to uncover possible linkages between the two parties and countries – planning that began with a simple cold call to the director of the Grains Research Laboratory at the Canadian Grain Commission (CGC) in Fall 2006. Many phone calls, emails, and rescheduled trips later, we were able to procure this and other highly successful meetings during the course of the week.

Not knowing much about grain and grain production in Canada, I relied heavily on the idea of “Investigative Selling” – asking many questions to uncover the possibility of partnership development and understanding the mutual benefit on both sides. This is a topic on which I will write further, but with this successful trip just concluded, I wanted to share this positive experience to those seeking partnerships from organizations and companies that may not appear to be a good match or may seem impractical because of geographic constraints.

Most importantly, it emphasizes the importance of treating partnership development as you would sales development. Without clearly presenting the benefit to the target organization, the chances for moving the relationship forward can be diminished. Fortunately, I was able to find the right person at the CGC who was willing to be proactive and consider the seemingly odd proposal of considering a partnership with a research facility in Kazakhstan.

And finally - if you've never visited Saskatoon in the summer - you are in for a very pleasant surprise. Wonderful city with great people and surprising restaurants. We were in Saskatoon on the first day of summer and finally saw the day creep into night at 11:00 PM, and morning arrive well before 5:00 AM.

"Your ideas are wrong, but. . ."

The second of the key concepts presented at the SVASE "Leveraging Service Providers" lunch event was:

"Any idea you have is the wrong idea. But then you learn from running the idea and figuring out what works."

This concept was introduced by Christopher Keene, and I nearly laughed out loud in agreement. I thought immediately about Economic Information Services LLC. I founded the company to focus on technology transfer services for new developers based in the former Soviet Union. The territorial coverage was intended to include the entire CIS, including Russia, Moldova, Ukraine, the Caucuses, and Central Asia. I planned to go at this alone from my office in San Francisco. (“Entrepreneurship is a team sport!")

After six months of slogging along, I attempted to plan a three-week business trip to Kazakhstan and Ukraine by myself. This included the notion that I would be able to pin down local companies and government agencies in these markets to a specific day and time for a meeting well in advance. Well, it doesn’t work that way in Kazakhstan. In Kazakhstan, you notify someone of the week when you will be in the city, and then they inform you that they may be available, give you their cell phone number, and tell you to call them the morning of the day that you would like to meet. For an organization nut like me, you can imagine my consternation at this.

I enlisted the help of a friend in Almaty, Kazakhstan that assisted with collecting information and agreed to take his vacation time from the university when I was in town. By the end of the two weeks, I hired this friend away from the university to be the director of our Central Asia office that we decided to establish. From there, we were off and running.

And by the way, in the course of the two weeks we realized that there wasn’t the funding available to support a private sector company solely dedicated to assisting with technology transfer, and over the course of the next year, we transformed the company to provide investment banking, business plan development, and project management services – what the company exists as today.

This macro-level example is one of hundreds of ideas that I’ve had for Economic Information Services LLC that when put into motion, produced vastly different results. But only after acting on the ideas was I able to determine the correct path to success.

"Entrepreneurship is a team sport."

Last Thursday (6/14/07), I attended the SVASE "Leveraging Service Providers" lunch event hosted at DLA Piper's office in San Francisco. The speakers of the event were Christopher Keene, CEO of Active Grid Software and Radu Barsan of Redfern Integrated Optics.

A couple of key concepts were presented throughout the course of the discussion. The first of which was:

"Entrepreneurship is a team sport."

Although we all here about the tremendous success and innovations of Bill Gates and Steve Jobs, their success was only made possible through the major contributions of those around them. This is a key idea with which those in the start-up world struggle – founders struggling with the necessity to delegate key aspects of the business to others and venture capitalists struggling to help company founders understand this concept.

At Aplia, I stepped into the lead Business Development role with semi-defined company structure in place. There were those that focused on product management, those that focused on content development, and those that did business development. Though we all cross-pollinated with support to each other, this structural concept was well enough defined already that those of brought on to the team for a specific purpose. And most importantly, the company founder was generally supportive of loosening the reigns to each of us to excel at what we did. Of course, there were always developments and conversations behind closed doors between the founder and CEO, but the fact that there was a CEO separate from the founder showed the understanding that entrepreneurship had to be a team effort.

There are important applications in for those leading teams in larget organizations as well. I can remember my first district sales manager at Prentice Hall – William “Butch” Porter (now the CEO of Optimized Learning. It seemed that he was only a “manager” for a few months each year – mostly in the summer between sales cycles in the Spring and Fall. During this time, he helped to define sales targets, territory goals, and lead training to increase our capabilities. The rest of the year, he took the active role of a customer service and sales support personnel, insuring that each of the reps had the adequate resources to close the sale. He had the faith that he hired the right people to do the job. Same concept as understanding that business is a team sport, even as a manager.

Tech Events - Silicon Valley/Bay Area

Launch Silicon Valley was held last week at the Microsoft Mountain View campus on June 4-5. I was pleasantly surprised by the turnout of both entrepreneurs and venture capital representatives.

Of the presentations that I attended, the Digital Media group was the most interesting to me. The presenting companies included - EyeJot, fix8, SnapJot, Yodio, and Catalog Data Solutions. The boom of applications becoming available for Web 2.0 and the influx of user-generated content was quite remarkable. Since working with Aplia four years ago, the model for USG has changed dramatically. This is obvious given the boom in personal network pages and You Tube, but it was compelling to see new companies continuing to emerge with alternate approaches to the market.

However, one aspect of the companies and presentations at Launch Silicon Valley noticeably absent was a clear explanation the sales and revenue models of their companies. Some companies appeared to integrate a mention of - "we are a SaaS model, charging a monthly subscription fee" - but few of them that announced this methodology provided a clear picture of how the revenue process would occur. In many cases, I found myself contemplating whether or not these companies had truly considered the revenue model aspect of their business, or were wed to a cool, new technology, excited about its creation and were operating over the assumption that "build it and they will come." It was an eerie flashback to 1999 in some cases. Of course, this outlook may be the product manager/business developer in me that is overlooking the fact that the presenting companies were almost exclusively operating on angel capital or bootstraps, but then again . . .

Private Equity in Education?

Laureate Education accepted a $3.5+ bln offer from an investor group that includes KKR.

With regard to Laureate, I am curious to see if and how private equity begins to creep into the public education arena - private equity is already purchasing mega-sized infrastructure projects such as toll roads and bridges. It is not much of a stretch to think that the private equity model of efficiency gains and increased organizational effectiveness would be a solution to attritting school performance acorss the US. The demands of taxpayers are constantly increasing. The competition for entrance to colleges and universities is cutthroat. Creeping into the for-profit education sector could be the first step into a foray to public education sector.

Private Equity & the Publishing Industry

Apax acquired Thomson Learning for over $7+ billion - nearly the same sale price as Chrysler!

Pearson plc recently acquired eCollege for approximately $500 mln., despite Pearson’s strategic partnership with Blackboard, Inc., a direct competitor to eCollege. Additionally, this price reflects a value nearly equal to eight times revenue and 20 times EBITDA.

I am closely monitoring the current and proposed transactions in the publishing industry. With over seven years of experience in this industry, I believe that there are significant inefficiencies that exist within the market participants. The major publishing houses maintain internal brand and production silos within their organizations, often duplicating product development, sales, and distribution services. In these cases, there are opportunities to divest these brand silos individually, with the sum of parts worth more than the whole and thus providing an opportunity for an experienced private equity fund to execute these transactions profitably.

In addition, traditional publishing companies have been challenged by an increasing number of distribution competitors, such as used books sellers overseas and new technology companies offering customizable, user-generated content. Companies with modernized distribution channels versus traditional publishers (such as the relationship of News Corporation and Dow Jones) will be able to leverage these channels to better meet market demands, and again give rise to a profitable outcome.

These industry conditions present an interesting value proposition for private equity firms experienced in capitalizing on these types of market inefficiencies, resulting in more effective and profitable companies. I suspect that this may be a main proponent of Apax Partners’ cash purchase for Thomson Learning, a price considered to be exorbitant by some executives within the publishing industry.

International Markets

Given my direct experience working in the emerging markets of the former Soviet Union, I am often asked about the quality of companies listed on public exchanges in countries like Ukraine, Russia, and Kazakhstan. My first response is that I am not a licensed broker and therefore cannot directly offer investment advice. That said, an interesting report published earlier this year from Concorde Capital in Kyiv, Ukraine caught my attention:

"20.02.2007
Only 7 Ukrainian Companies Approach International Corporate Governance Standards

"Concorde Capital became the first investment bank to conduct a comprehensive study of corporate governance in Ukraine. The study’s intended audience is foreign investors who invest in shares of Ukrainian companies.

"We rated 118 companies, including several listed on foreign exchanges, encompassing all sectors of the Ukrainian economy. We chose companies based on their investability and overall interest to investors. For these reasons we have decided to make Reporting & Disclosure, Investor Relations, Minority Concerns and Strategic Risks the focal point of our report."

(A full copy of the report is available on the Concorde Capital website.)

In short, this is a stark reminder to those anxious to invest in these emerging markets. From my experience working and travel in Ukraine, this report is certainly not a surprise. I have regularly faced objections and refusals when working with companies in these markets regarding accounting transparency issues.

But if governance and transparency are an issue, how is it that the PFTS Index has risen from the mid-60s to 950 in the past 3 years. Not a bad return. . .