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Why Google's Alphabet shakeup makes sense

Yesterday, Google caught the tech world off-guard with a major reorganization. In the months to come, what we now know as Google will become Alphabet, with "Google" now referring to just the core businesses of Search, Android, YouTube, and a handful of others, overseen by new Google CEO Sundar Pichai. From AT&T to IBM to GE to Microsoft, tech companies have always searched for a way to avoid becoming the next incumbent that gets complacent and then disrupted. Google tried X, now it’s trying Alphabet.

On the surface, the only difference is the name. The core business is still targeted advertising, and those profits are still funneled into a web of experimental schemes that may not ever turn a profit. But the new division between Google and Alphabet is more complex than a simple name change, and it may allow two increasingly separate halves of the Google empire to drift ever further apart. So what does Google — or Alphabet — get out of all of this?

Investors have never particularly liked Google's moonshots

The easiest answer is placating investors. Wall Street has never particularly liked Google's moonshots, and on earnings call after earnings call, investors have raised objections over how much those experimental R&D projects are costing the company. But while Page and Brin aren't backing off those projects, they are offering a closer look at how all the numbers separate out. As early as Q4, the company anticipates "two reportable segments…with the Google business presented separately from other Alphabet businesses taken as a whole." The result will be a holding company along the lines of Warren Buffett's Berkshire Hathaway, a company Page has specifically called out as a model in previous investor meetings. Under that model, Alphabet can be a collection of some profitable businesses and other not-so-profitable businesses expected to bear fruit in the future. The Google half can be considered individually, with the rest left to stand or fall on its own merit.

If the non-Google portion sounds less like a company and more like a venture capital firm, it should. As they've pulled away from Google's day to day business, Page and Brin have grown more and more interested in ideas that look an awful lot like startups, whether it's drone-mounted wind turbines or breakthrough battery tech. Even Nest, the one consumer-facing division left out of the new Google, started out as a scrappy hardware firm facing long odds. But while Google could easily fund ambitious projects through Google X, launching those projects into a Google division or a standalone business has proven awkward. Under Alphabet, those projects will be nudged back in the startup direction, with more financial options when a project succeeds and more accountability when a project fizzles out.

The new CEO of Google Auto could raise independent funding or launch an IPO

Google's self-driving program is a perfect example. It could bring the company immense profits some day, but it has little in common with Google's core business and might scare off investors looking for slow and steady Search revenue. If Alphabet wants to give the Auto division a boost without spooking investors, it can allow the company to raise outside funding, exchanging a small ownership stake for liquid cash or a strategic partnership. And as the company develops, the CEO of Google Auto could consider her own IPO, rewarding Alphabet shareholders and outside investors in turn.

That's particularly important since investors can be fickle when it comes to Google's more ambitious projects. There are still a lot of potential investors for self-driving technology, but they're just a small slice of the investors willing to buy shares in Google's down-the-line advertising business. That means that as long as the companies are bundled together, small risks can have a disproportionate effect on Google's share price.

The biggest losers could be projects like Fiber

The possibility of a public offering will also make it easier to attract and retain top talent. The person charged with running Glass or Loon will now be CEO of a quasi-independent company rather than project manager of a minor Google branch — a major difference for anyone concerned with resumé building. Executive retention has been a real problem for Google in recent months, most recently with Maps chief Brian McLendon leaving for Uber, and Google said in its SEC filing that it thinks the new structure "allows us more management scale."

If there's a loser in all this, it could be projects like Fiber that fall in between the wild moonshots and the reliable moneymakers. Laying fiber optic cable is an expensive process, far more expensive than developing prototype balloons or contact lenses, but for Fiber that expense was justified by its network effect on Google's bottom line. Cheaper high-speed access would mean more Search eyeballs and more users for high-bandwidth services like HD YouTube and Hangouts. By many measures, the project has been wildly successful, upending the market for internet access in every city it has entered, but now Fiber will have to justify its existence to a very different audience. For a project like Glass, which seems to anticipate a Search or Android integration that’s never quite taken shape, the prospects are even harder to predict.

Still, it's hard to believe Page and Brin would have made the Alphabet shift if they believed it would seriously hamper their side projects. What's more likely is that those projects will no longer have to justify themselves as adding value to Google's advertising business. Now they'll be standalone operations, to rise or fall on their own. Instead of hiding under a single mantle like Google X, they'll be individually accountable, and activist shareholders will be able to target them one by one, as they have with Sony in recent years. In exchange, Alphabet is dealing a major blow to anyone hoping the leadership would shut down Google X and focus on search ads. Those long bets are now baked into the most basic DNA of the company, and Page and Brin have little reason to stop making them. The only question is, now that they've staked a bet that Alphabet is bigger than just Google, are they right?

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