Surprise collapse in Google’s share price offers a warning for all companies

Paul Ormerod
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THE dramatic crash in Google’s share price and the temporary suspension of trading in its shares made headline news. The event was triggered by a 20 per cent year-on-year fall in profits in the third quarter of this year.

As usual, there was no shortage of explanations for why this happened – after the event, of course. A simple search of Yahoo! Finance of more than 40 brokers shows that, in the previous three months, all had recommended “strong buy”, “buy” or “hold”. Not a single one classed the stock as “underperform” or “sell”. Indeed, over the whole previous year, Google’s share price had risen more or less continuously, by a total of around 30 per cent.

But once the collapse happened, everything became crystal clear. It was apparent that Google’s $12.5bn (£7.8bn) acquisition of Motorola was a mistake, as the mobile phone manufacturer has been left behind by fashionable rivals. It was also obvious that advertisers were reducing their payments on click-through ads because of the switch to mobile devices by consumers.

It is fun to mock analysts when they are wrong. But the Google incident has wider implications for the sort of world in which companies now have to operate.

We are in a state of flux about how to set prices in the revolutionary medium of the internet. Standard economic theory is no help at all. It tells a company to set prices equal to marginal cost – in other words, to equate its prices to the cost of producing and selling one more item. But for many web-based applications, the marginal cost is zero. Once your system is set up, it costs nothing when the next customer clicks on the site. All we can say is that we are in a process of rapid evolution, and no one has yet worked out a satisfactory answer on price.

The wider issue relates to corporate reputation. In the highly networked and connected world in which we live, companies can be blindsided by entirely unexpected reactions to events. Google knew about Motorola and advertising rates. More importantly, Google knew that the analysts knew. But the actual reaction seems to have come as a complete surprise to everyone involved.

In a similar way, news of MPs expenses eventually exploded into a crisis that shook the country’s political foundations, while the phone hacking undertaken by some in the media swiftly brought down the News of the World, a former stalwart of Britain’s fourth estate.

This inherent uncertainty about which stories will gain traction, and in what way, is a deep feature of networked systems – systems in which people react to the reactions of other people. Even small scale events or an adverse comment on a blog have the potential to go viral. Understanding and managing reputation in this new, emerging world is a major challenge for all companies.

Paul Ormerod is an economist at Volterra Partners, a director of the think-tank Synthesis and author of Positive Linking: How Networks Can Revolutionise the World (Faber & Faber).