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.