Blog Post

For Google, Capex Costs Are Worth the Money

Google’s (s GOOG) recent push into tablets and mobile, along with offering new search services such as Google Instant, are pushing up the company’s capital expenditures, which are slotted to grow almost 184 percent in 2010 compared to last year. Next year, that amount is going to go even higher. This spending is a good thing, because it allows Google to leverage its inherent advantage: infrastructure.

A few years ago, I noted in a post that infrastructure was Google’s key competitive advantage. It’s what allowed the company to innovate and outpace its rivals. It allowed the company to give us results faster than our broadband connections could offer, making us more subservient to its search in the process. In the end, we all forgot the directories and instead focused on the search-box as the start of our Internet journey. Today, Google is a gigantic, $7.3-billion-in-quarterly-sales business.

One thing Google knows: It needs to keep spending money on this infrastructure in order to stay competitive and current. The company recently introduced Google Instant, a new feature that allows you to get results even as you’re still typing the search term. It’s a service akin to the days when an Intel (s intc) chip got multimedia extensions.

In many ways, Google Instant demonstrates the evolution of a product in order to keep up with times; today’s faster broadband means that the search results need to come up faster than one could type. More importantly, Google Instant is a search product optimized for a brave new world where the user interface is touch rather than keyboards, and devices aren’t your classic computer, but instead mobile and tablet-like.

One of the reasons Google was able to launch Google Instant is because it can afford to spend a lot of money on its infrastructure. During the third quarter of 2010, the company spent nearly $757 million, the highest amount since the first quarter of 2008, according to investment bank J.P. Morgan (s jpm). (In comparison, Google spent a total of $810 million on capital expenditures in all of 2009.) In a conference call with Wall Street yesterday, Google VP Jonathan Rosenberg told the analyst community:

From a revenue standpoint, its impact has been very minimal; and from a resource standpoint, it’s actually pretty expensive. So why did we do it? Well, we believe from a user standpoint, Instant is outstanding and the data that we are seeing actually bears this out.

Google’s spending on capital expenditures (mostly on data centers) had been on a decline. That is about to change. According to J.P. Morgan, the company is going to spend $2.3 billion on capital expenses in 2010 versus $810 million last year. For next year, the investment bank  is forecasting $3.2 billion in capital spending.

Some Wall Street analysts are going to view this increased spending and wring their hands. They’re idiots and short-term thinkers. I see the growth in capital expenses as a sign of health, and that things are going well for Google –actually, really well.

Let me explain; until recently, Google had to focus on a small subset of actions to satisfy its end customers – all of us – and thus make money off of advertising. Throw in YouTube videos and Gmail, if you want, but browser-based search and search-based advertising were its bread and butter.

Google is said to be the single biggest source of traffic on many of the world’s networks and that’s with only a handful of offerings. Now imagine how big Google will be as a percentage of the source of Internet traffic once we start taking their new initiatives into account. That also explains why they need to build their own networks and lay their own fiber pipes.

Now the number of consumer interactions has grown multifold. Google’s Android mobile operating system is an Internet-enabled OS peppered with Google services that are used more frequently because we have access to them in our pockets. This overall growth in data center capabilities is only going to go up as the company becomes more successful with its Android push. By spending on data centers and networks, what Google is ensuring is that Google Android will always have a great user experience. Remember, in a world dominated by cloud clients, nothing matters more than instant access to various Internet services.

Related content from GigaOM Pro (subscription req’d) about Google, and its Mobile Efforts:

11 Responses to “For Google, Capex Costs Are Worth the Money”

  1. Google is SO about infrastructure that they can just drop bombs like Maps, or Docs, or Instant Search – and everyone forgets what they were just excited about.

    Yahoo is such a vaporous bag ‘oh’ stink.

  2. Google’s going to be introducing Google TV.

    They will need to add a lot of infrastructure to manage the video traffic and the storage of the content that they will be providing.

  3. I just realized your article on infrastructure as Google’s competitive advantage was written in 2007. Great insight back then.

    I am impressed that Facebook managed to scale so quickly as well (with the occasional bump). Would you consider that ability a competitive advantage of Facebook as well? Or are infrastructure architects becoming more & more common, thus potentially removing the advantages of such an ability?

  4. Derrick Harris

    Spot-on analysis, IMHO. Some analysts questioned Amazon’s recent data center spending, too, despite AWS leading the cloud computing movement and seeing skyhigh demand.

  5. modelportfolio2003

    You have produced a very thoughtful piece on why cap ex growth is so important to Google. Analysts on Wall St are very short term oriented and if they do not worry about increased hiring numbers (Google hired 1500 this past quarter, as reported), they worry about anything else that will have a potentially adverse affect on margins growth. Google actually expanded EBITDA margins by 30 basis points quarter over quarter, despite the surge in cap ex you cite. That is no small achievement. With newer sources of income (display and mobile), the need for satisfying users need for speed and quality of result/targetted ad, etc, cap ex should continue to be a major differentiator with its competitors. As Google layers on more social and other services onto its existing product range, avoiding downtime yet spending money “frugally” (as the CFO says) will be a on-going challenge.

  6. I absolutely agree that infrastructure is one of those things that ensured Google could manage to outdo its competition in every initiative that is now mainstream (Search, Youtube, etc.). And it’s grating that Wall Street analysts would do just what you said — wring their hands when hearing about the increasing capital investment. And I liked the words you used for them: idiots and short-term thinkers. Pandering to them will only result in what happened to HP during Mark Hurd’s term.