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It may have finally found the missing piece it needs to move beyond relying solely on advertising.
February 18, 2014

When it comes to developing software, few companies can match Google’s prowess. It doesn’t just have the most popular search engine. Chrome is the most widely used Internet browser. Gmail, Calendar, Spreadsheets, Docs, and Presentations are legitimate alternatives to Microsoft Office. Picasa, Google’s free photo management software, might be as good as anything from Apple. Android dominates the phone and tablet landscape. Google Maps is becoming the best navigation program on any device.

And yet by one important measure, Google hasn’t been innovative enough. The vast majority of its revenue comes from ads—the ones in search results and the ones that Google pushes out to thousands of websites. These were amazing innovations when Google developed them back in 2001 and 2002. But Google’s many efforts to develop additional ways to make money haven’t gone very far.

Perhaps Google’s most public failures have been in consumer electronics. Do you remember Google TV? The Nexus One? The Nexus Q? If you do, it’s probably not because you bought one. Google acquired Motorola Mobility for $12.4 billion in 2012 in an effort to finally build products that consumers wanted to buy. But Motorola’s market share fell on Google’s watch; the deal soured so fast that Google is now selling off most of Motorola to Lenovo. In the end Google will have spent about $3 billion to get a chunk of Motorola patents.

Google’s problem is straightforward: its culture is rooted in building software, giving it away, and improving it over time—all with little in the way of advertising or marketing. Selling stuff requires the opposite—persuading customers that the product for sale is finished and perfect in every way.

So why can’t Google just accept the market’s judgment of its strengths and weaknesses and stop wasting shareholders’ money trying to expand the revenue base? Because even though there is every indication that Google’s advertising business will keep growing for years to come, nothing guarantees that it will dominate forever. Something could come along and do to search ads what search ads did to TV and newspaper ads.

That is why Google still hopes to compete with the likes of Apple in consumer electronics. And it’s not too late, especially with Google’s $3.2 billion purchase of Nest Labs in January.

Of course, acquisitions are rarely magic bullets, as Google can attest. And look at the business Nest is in: it makes home thermostats and smoke alarms, which, to be kind, have been on the trailing edge of innovation. But that’s what makes this purchase interesting. Nest has transformed these moribund categories with clever products that learn their users’ preferences and feel like things you would buy in an Apple store, which in fact is one of the places they are sold. Even though Nest’s thermostat costs $250, market analysts estimate that consumers have been buying more than 50,000 units a month.

What really made the Nest deal attractive, however, was the people. Nest’s CEO and cofounder is Tony Fadell, the former Apple executive who was critical in that company’s rebirth. He helped build and design the iPod, and then he helped conceive and build the iPhone. Fadell and cofounder Matt Rogers, who was also one of the early iPhone engineers, have hired roughly 100 of Apple’s top engineers and marketers, according to public profile data on LinkedIn. They made Nest one of the largest repositories of ex-Appleites in Silicon Valley.

Indeed, buying Nest could be Google cofounder Larry Page’s most important deal since he became CEO in 2011. Motorola didn’t bring much expertise in design or marketing, whereas Fadell spent a decade working for Steve Jobs, giving him insights he used to turn Nest into an overnight success. Now he reports to Page, and Google might finally produce a new kind of innovation.

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