Paul Ormerod: If it can happen to Google,  who can feel safe?

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

As usual, there was no shortage of explanations of why this happened – after the event! 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 ‘under-perform’ or ‘sell’. Indeed, over the entire previous year, Google’s share price had risen more or less continuously. The total increase had been around 30 per cent.

But once the collapse had happened, everything became crystal clear. It was apparent that the $12.5 billion acquisition of Motorola had been a mistake, because the cell phone manufacturer has been left behind by fashionable rivals. Further, it was obvious that advertisers were reducing their payments on click-through ads because of the switch to mobile devices by consumers.

It is good fun to mock highly paid analysts when they get things wrong. But the Google incident has much wider implications for the sort of world in which companies now have to operate.

A specific point concerning the internet is that we are still in a state of flux about how to set prices in this revolutionary medium of communication. Standard economic theory is no help at all. This tells a company to set price equal to marginal cost. In other words, to equate price to the cost of producing and selling one more item. But for many web-based applications, the marginal cost is to all intents and purposes zero. Once your system is set up, it costs nothing when the next customer clicks on the site. Any company following this economic precept on pricing would soon go bankrupt. All we can say is that we are in a process of very rapid evolution, and no-one has yet worked out a satisfactory answer on price.

The wider issue relates to corporate reputation more generally. 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, the company and the analysts.

The publication of the notorious cartoons of Muhammad in Denmark attracted little attention, despite vociferous protests from Danish Muslims. Four months later, the Muslim world erupted in reaction to them.

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 LLP, a director of the think-tank Synthesis and author of Positive Linking: How Networks Can Revolutionise the World