Is Alphabet more than just Google search?

Is Alphabet more than just Google search?

The Fog of Confusion: Google’s Battle in the Age of AI

Last November, the headquarters of Alphabet, Google’s parent company, was shrouded in an unusual fog – not the weather kind, but a fog of confusion. This was caused by ChatGPT, an AI conversationalist developed by OpenAI, which was giving eerily human-like answers to user queries. Naturally, this caused panic at Google, as answering questions is the foundation of their search business. The fear was that OpenAI and Microsoft’s Bing search engine were poised to snatch Google’s market share. But fast forward eight months, and the mist has mostly cleared. Google’s latest quarterly results show solid growth, with revenues reaching $75 billion. Bing has failed to make a dent in Google’s dominance, with the company still capturing over 90% of global monthly search queries.

Google has successfully dispelled any doubts about falling behind technologically. In May, CEO Sundar Pichai unveiled a range of AI-powered products, including AI tools for Gmail, Google Maps, and Google Cloud. This reassured investors, especially after a bumpy launch of Bard, Google’s chatbot, which made a factual error. Since then, Google has been on a roll, launching various AI products and features. Recent developments include NotebookLM, an AI-assisted note-taking tool, and an AI model that matches human doctors’ treatment recommendations. The company is also working on an AI model, codenamed Gemini, to surpass ChatGPT. These strides have contributed to Alphabet’s market value rebounding to $1.7 trillion, from a low of $1 trillion in November.

With the crisis seemingly over, there are larger questions at play. Google, as one of the world’s most successful companies, is approaching its 25th anniversary in September. People are wondering about the state of the company, its future prospects, and the challenges it faces at different stages of its corporate life.

The Top of the Mountain

Alphabet is undeniably one of the greatest business success stories. Google alone boasts more than 2 billion monthly users across its six main products, including search, Android, Chrome, Google Play Store, Workspace, and YouTube. Collectively, users spend a staggering 22 billion hours a day on Alphabet’s platforms, which translates into immense value for advertisers. Google’s revenue, primarily generated from online ads, has grown at an average annual rate of 28% since going public in 2004. The company has accumulated $460 billion in cash after operating expenses, and its share price has risen 50-fold, making it the world’s fourth-most valuable company.

While these numbers are impressive, questions arise about why Alphabet isn’t doing even better. The core digital advertising business is maturing, with sales growth no longer consistently in double digits. Additionally, finding new sources of growth becomes challenging for a company with $300 billion in annual revenues. Investors are demanding greater cost efficiency and capital discipline, prompting a need for a shake-up in Alphabet’s corporate culture.

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Digital advertising, once seemingly invulnerable to economic cycles, is facing challenges. With the online share of total ad spending reaching two-thirds, businesses have smaller non-digital ad budgets to allocate. Global sales of digital ads are expected to grow by 10% or less annually in the next few years, down from the 20% rate of the past decade. Trustbusters also argue that Google’s already dominant market share is too high, while its arrangement with Apple to be the default search engine faces scrutiny. Furthermore, changes in consumer behavior pose a threat to Google’s search supremacy. Product searches now often begin on Amazon, and younger generations seek recommendations through apps like TikTok and Instagram.

The rise of chatbots and generative AI adds another layer of complexity. Google’s focus on AI demonstrates it is an “AI-native” company. While solving technical challenges associated with chatbots, such as hallucinations and high costs, may be within Google’s reach, the question remains: How financially successful will these AI-powered products be? Despite Alphabet’s engineering prowess, previous attempts to monetize exceptional products have fallen short. For example, Alphabet’s share price continues to lag behind Microsoft, which is successfully monetizing generative AI in its software products.

Placing New Bets

Recognizing the eventual slowdown of its primary revenue engine, Alphabet, through its dual-class ownership structure, created a holding company in 2015. Alphabet houses Google and various other ventures, including ambitious “moonshots” like self-driving cars and life-extending medicine. However, most of these moonshots have yet to show commercial promise. Other Bets, the division where these moonshots reside, has accumulated a cumulative operating loss of $24 billion between 2018 and 2022 – over six times higher than its total revenues in that period.

Expanding into new markets is challenging, as most industries aren’t disruptive enough to make a significant impact on Alphabet’s top line. It requires substantial investments for uncertain returns, without the capital-light quasi-monopolies that Google has enjoyed with search advertising. Despite Google’s investments in health-related startups and cloud services, results have been underwhelming. Silicon Valley companies like Apple and Microsoft have made more ambitious forays into finance and healthcare, but Alphabet’s efforts in those areas are linked to its ads business rather than a genuine attempt to become a major player.

Alphabet’s biggest bet lies in becoming a force in cloud-based, AI-enhanced business software through Google Cloud. However, intense competition from Amazon Web Services and Microsoft Azure poses challenges. Google Cloud has been offering customers competitive deals to catch up, achieving growth rates of 40% annually. While the unit has recently turned a profit, the enterprise cloud market is cyclical and cutthroat. Furthermore, Amazon and Microsoft have long-standing relationships with corporate clients, whereas Google lacks a solid business-to-business foundation. As one former executive noted, despite Google Sheets being exceptional a decade ago, it failed to gain traction due to a lack of engagement with chief information officers.

Froogle Living

As revenue growth becomes more elusive, investors are calling for improved margins to enhance returns. Alphabet’s shares trade at a lower price-to-earnings ratio than Apple or Microsoft, and only marginally higher than the overall S&P 500 index. To address these concerns, hedge funds like TCI, Pershing Square, and Third Point have urged Alphabet to optimize costs and increase discipline.

Alphabet’s loose management structure and bloated employee count have attracted criticism. With nearly 190,000 employees, double the number in 2017, Alphabet faces accusations of paying its employees too much. The typical Googler takes home almost $300,000 per year, significantly higher than counterparts at Microsoft and other tech firms. TCI’s letter highlighted the need for greater capital allocation efficiency, implying that Alphabet’s scattershot approach was only justifiable when masked by strong returns from the core business.

In response, Alphabet has begun implementing changes. Several Other Bets have been shelved, and the AI labs, DeepMind and Google Brain, have been merged for better resource and talent utilization. The company has also made significant personnel changes, promoting Ruth Porat to president and creating a chief investment officer position to guide capital allocation. This newfound discipline aligns with Google’s incrementalist approach – doing more with constraints and introducing AI features to existing products. However, this approach will be tested as AI progresses, requiring both technical expertise and commercial innovation.

The Hazy Path Forward

As Alphabet nears its 25th anniversary, the company recognizes the need to slim down, avoid risky ventures, and enforce discipline. By doing so, Alphabet aims to increase its bottom line, even if overall sales growth slows. However, this incrementalist strategy will face challenges as AI continues to develop. Engineering prowess, while critical, won’t be sufficient to fully leverage AI’s potential. Successful monetization will require commercial ingenuity, an area where Google has historically struggled. To navigate this path successfully, Alphabet must shed its scattershot approach and fully leverage its engineering talent. If the company fails to adapt, hungry competitors are ready to seize the opportunities presented by AI’s dawn.