Even Google Gets Frugal in the Recession

Even Internet superstars fall to earth eventually. While recent reports of layoffs and other cost-cutting measures at Google have been greatly exaggerated, the search giant's culture of unbridled spending is finally coming to a halt. And that's probably a good thing. "Hard times have forced discipline on them," says Sanford Bernstein's Jeffrey Lindsay, who predicts, "They'll come back really powerfully. They can emerge as a much leaner and more competitive player."

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It's not just afternoon tea that's falling by the wayside at the famously employee-friendly firm. Although Google hasn't handed out pink slips to any of its 20,000 full-time employees, it has cut about half its additional 10,000 contract workers in recent months. Previously one of the biggest recruiters of M.B.A.s on college campuses, Google is now eschewing such pricey new hires, although it is still bringing on new engineers.

Most analysts forecast decent growth for Google in 2009. But Trip Chowdhry of Global Equities Research predicts that the firm will lay off anywhere from 10% to 15% of its employees in 2009 as a result of stagnating revenue. "This is not only for Google. This is for every Internet company that has only one revenue source, which is advertising," says Chowdhry. He estimates that the company will bring in $14.57 billion by 2010, down 4% from an estimated $15.71 billion in 2008. Sanford Bernstein's Lindsay, on the other hand, recently lowered his upbeat forecast for the search giant but still expects a healthy 19.5% increase in revenue in 2009. (See pictures of "Life in the Googleplex.")

Lindsay's forecast is nowhere as dire as Chowdhry's. But both analysts are reacting to reports that the cost-per-click for Internet ads has fallen an estimated 20% this year. Google and other Internet-advertising companies make much of their money by serving up ads that match keywords that people type into search engines. The rates for those ads are determined by advertisers, who bid for top placement. But advertisers have begun lowering their bids because they aren't getting the returns (also known as conversion rates) that they expected. In late November, research firm eMarketer lowered the 15% increase in online ad spending for 2009 that it had projected in August to just under 9%.

Google's new CFO, Patrick Pichette, is leading the company's belt-tightening. A former executive at Bell Canada, his impact was already evident in the firm's third-quarter results, which it announced in October. Although the company's revenue was slightly lower than analyst estimates, earnings were higher due to cost-cutting measures spearheaded by Pichette, such as decreasing the number of new hires. "Google has certainly gotten religion on expenses, and that is due largely to the new CFO," says Sanford Bernstein's Lindsay.

Now Google needs to focus on its core businesses like search, mail and Web-based applications, instead of pouring endless resources into experimental projects that never turn a profit (such as its ill-fated virtual world Lively, which will close at the end of month). "If they could fix their expense management, surely they could fix their product development as well. Google has a very poor product-development process," says Lindsay, who criticizes the firm for letting good products languish while encouraging engineers to tackle newer and more exciting projects instead. For example, its Chrome browser got positive reviews when it was released this summer, but it hasn't been marketed or significantly updated since then.

CEO Eric Schmidt told the Wall Street Journal that he plans to prune the company's offerings in the coming months. It will also try to monetize some previously ad-free products like Google Finance and News. Such efforts may help it weather the economic storm without resorting to layoffs, even if it doesn't bring its stock price any closer to the November 2007 high of $732 per share. (It closed on Wednesday at $279.) And it's still got some $14 billion in cash reserves. So for now, at least, the free lunches are still a go.

Yang's Exit: Did Yahoo!'s Chief Get Played by Google?

Testing Google's "Drunk E-Mail" Protector.