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Google Earnings: Still Minting Money Despite Big Strategic Weaknesses

Google (GOOG) may be a one-trick-pony when it comes to how it makes money. But as its second quarter earnings show, it remains really good at its one trick. Revenue of $9.03 billion was up 32 percent year-over-year and net income was $2.51 billion, up 36 percent over last year's $1.84 billion. That's a still-hefty gross margin of 35 percent, even though it's down from the 37 percent of 2010.

While the company threw off a staggering $4.9 billion in free cash during the first half of the year, it still faces significant danger in how it makes its money. Management could close down all non-ad revenue sources and scarcely notice the difference. And Google's emphasis on its own sites, versus those of its ad network members, should start to concern companies that depend on Google's various ad delivery mechanisms.

The tables that show this clearly come, as always, at the bottom of Google's earning release (click to enlarge):

After a period in 2010 when Google at least seemed to be diversifying revenue sources, the reversal is pretty complete. During the first six months of 2011, Google got only 3.3 percent of its revenue from sources other than ads, compared to 4.1 percent during the same period in 2011.

That seems pretty screwy when you realize that for the first six months in 2010, R&D represented 12.6 percent of revenue, but in 2010 it jumped to 14 percent. Just what are they spending the money on? New ad mechanisms? At what point does the research help balance out Google? (And does the R&D spending represent the company's many acquisitions, or is that essentially additional research and development put into some other category?)

Crazy to argue with success? Maybe not
It might seem crazy to argue with the company's success -- unless you've ever watched an ad-dependent business suddenly react to a drop beyond its control. Sure, Google is working hard to diversify its sources of ads, with increased work on YouTube and, of course, Android (which, I've argued, brings in far more than most people suspect).

But what happens if the studios push more toward Netflix (NFLX), which is directing its business as much toward streaming as it can? And what happens if Microsoft (MSFT) and Oracle (ORCL) are successful in crippling Google's success selling the mobile operating system?

Google's business partners should be concerned about ad revenue split between Google's own sites and those of network members. Google's own sites climbed two percentage points and grabbed most of the absolute dollar growth. The company has clearly said before that it wants to pull more ad business to its own sites because it makes more money without having to pay its partners for traffic acquisition.

For all the revenue and all the cash available, Google continues to have some big weaknesses, and CEO Larry Page doesn't seem to see them.