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Is there more to Alphabet than Google search?

As the tech firm nears 25, investors and executives alike look for fresh sources
of growth

Jul 30th 2023 | MOUNTAIN VIEW

Last November something strange happened in Mountain View. A thick fog enveloped the
headquarters of Alphabet, the parent company of Google. Not the meteorological sort—this stretch
of Silicon Valley is reliably sunny. It was a fog of confusion. Its cause was Chatgpt, an artificially
intelligent conversationalist created by Openai, a startup backed by Microsoft. The effect was, by all
accounts, panic. Chatgpt was giving uncannily humanlike answers to questions put to it by users.
And answering questions is the bread and butter of Google’s lucrative search business. Were
Openai and Microsoft, which in February launched an enhanced version of its Bing search engine,
about to eat Google’s lunch?

Eight months on the mist has mostly cleared. On July 25th the company reported another set of
solid quarterly results. Revenues rose by 7% year on year, to $75bn. It continues to create piles of
cash: in the 12 months to June it raked in $75bn of operating profit. Bing has taken no discernible
bite out of Google’s share of global monthly search queries, which remains above 90%.

Most important, Google has put to rest any notion that it has fallen behind technologically. In May
Sundar Pichai, chief executive of both Google and its corporate parent, unveiled more than a
dozen ai-powered products at i/o, an annual event for software developers. These included ai tools
for Gmail, Google Maps and Google Cloud. Investors found it reassuring—not least after a rushed
launch in February of Bard, Google’s chatbot, during which the ai helper made a factual error.
Alphabet’s share price leapt by a tenth after Mr Pichai’s presentation (see chart 1).
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Since then the firm has launched ai products and
features left and right. On July 12th it brought out
Notebooklm, an ai-assisted note-taking tool
trained on a user’s documents. On the same
day Nature, a scientific journal, published a paper
by Google researchers describing an ai model that
matched human doctors’ responses to questions
about the right treatment for patients. A day later
it expanded a now less error-prone Bard,
proficient in more than 40 human languages and
over 20 computer ones, to the eu. Work on
an ai model to eclipse Chatgpt, codenamed
Gemini, is proceeding apace. Having nearly fallen
below $1trn in November, Alphabet’s market
value is back up to $1.7trn. Crisis over?

In the short run, probably. Like all heart-in-

mouth moments, though, the chatbot panic
invites broader questions: about the current state
of one of the world’s biggest firms, its future
and—as Google turns 25 in September—about
the demands of different stages of corporate life.

The view from the top

Alphabet is, without a doubt, one of the greatest business successes of all time. Six of its products—
Google search, the Android mobile operating system, the Chrome browser, Google Play Store for
apps, Workspace productivity tools and YouTube—boast more than 2bn monthly users each. Add
those with hundreds of millions of users, such as Google Maps or Google Translate, and, by one
reckoning, humans collectively spend 22bn hours a day on Alphabet’s platforms.

The ability to command so much attention is worth a lot of money to the people who want a slice of
it, namely advertisers. Since going public in 2004 Google’s revenue, 80% of which comes from
online ads, has grown at an average annual rate of 28%. In that period it has generated a total of
$460bn in cash after operating expenses, virtually all of it from advertising. Its share price has risen
50-fold, making it the world’s fourth-most-valuable company.

Given these eye-popping numbers, it may seem churlish to ask why Alphabet isn’t doing better. In
fact, the question is warranted, and is being asked by Mr Pichai, his underlings and investors alike.
The company finds itself at a delicate juncture—not only, or even primarily, because of ai. The core
digital-ads business is maturing, with sales growth no longer consistently in double digits and
increasingly tied to economic cycles. At the same time, finding new sources of material growth is
difficult for a company that brings in $300bn in annual revenues. This quest is further complicated
by investors calling for greater cost efficiency and capital discipline, which in turn requires a shake-
up of its free-wheeling corporate culture.

Consider the cash cow. Throughout the 2010s digital advertising seemed invulnerable to the
business cycle. In good times advertisers spent like there was no tomorrow. In worse ones they
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diverted some of their non-digital marketing budgets online, where Google and other giants like
Facebook (now Meta) offered to target adverts more precisely than a tv commercial or a page in a
glossy magazine could.

Now, as the online share of total ad spending

touches two-thirds, businesses have smaller
non-digital ad budgets to eat into. Insider
Intelligence, a data firm, expects global sales of
digital ads to increase by 10% or less annually
in the next few years, down from a rate of 20%
or so in the past decade (see chart 2). A
slowdown last year offered a glimpse of the
future, spooking investors.

Nor can Google easily capture a bigger slice of

the slower-growing pie. Trustbusters already
believe its share is too high and have sued
Google in America for abusing its search
monopoly. Google’s arrangement with Apple,
whereby it pays a reported $15bn a year to be
the default search engine on the 2bn or so
iDevices, has also come under scrutiny.

Although search remains immensely lucrative,

with operating margins of nearly 50%, according to Bernstein, a broker, how people look for things
on the internet is changing. Most product searches these days start not on Google but on Amazon,
the e-commerce giant. According to Google’s own executives, 40% of teenagers and young adults
seek recommendations for things like restaurants or hotels on TikTok, a short-video app, or
Instagram, a similar app from Meta.

Google may entice some of these “search-nevers”, as Mark Shmulik of Bernstein calls them, to its
platform, as YouTube is doing already with a TikTok lookalike called Shorts. Yet videos are unlikely
to monetise as nicely as the search box.

Then there are the chatbots and other “generative” ais that, having been trained on a web’s worth of
texts, images and sounds, can serve up simulacra of human-generated content. Mr Pichai’s
insistence that Alphabet is an “ai-native” company rings true. Most observers believe that deep
pockets and ample talent will allow Google to solve the technology’s teething problems, such as the
bots’ tendency to “hallucinate” (make stuff up) or the high cost of serving up responses (which egg-
headed Googlers are busy tackling).

That still leaves open the question of how much money bot-assisted products, for all their expected
ingenuity, will actually make. Set aside search, and Google’s knack for creating extraordinary
products is matched by its inability to monetise them. There is no reason to think that its ais will be
any different.

As for search, generative ai does not necessarily herald a financial bonanza. Today Google gets paid
when users click on the links to merchants’ websites that appear next to the responses to search
queries. Once the technological niggles with generative ai are solved—in two or three years, experts
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reckon—Google will have a choice to make, reminiscent of the “innovator’s dilemma”, a theory put
forward by Clayton Christiansen that argues that incumbents are reluctant to innovate if it
jeopardises their existing markets. If a chat with an ai is to feel natural, it cannot be peppered with
ads and links. Google could show fewer ads and charge clients more for each. But advertisers may
balk—or, worse, defect.

New bets
Google’s founders and, thanks to Alphabet’s
dual-class ownership structure, its overlords,
Larry Page and Sergey Brin, have long been
aware that its primary revenue engine was going
to slow at some point. They have sought to
supplement it and, one day, perhaps replace it
altogether. That was the main reason for the
creation in 2015 of Alphabet. The holding
company would house Google alongside various
other ventures, including out-there “moonshots”,
from self-driving cars to life-extending medicine.

Most of the moonshots look as commercially

questionable as the Apollo programme. Other
Bets, the bit of Alphabet where most of them sit,
haemorrhages money. Between 2018 and 2022
it notched up a cumulative operating loss of $24bn, more than six times bigger than its total
revenues in that period (see chart 3). Other Bets consumes at least some of its parent’s capital
spending, which ate up $31bn last year, and a material slug of its $40bn annual research-and-
development budget.

A deeper problem is that it is hard for any new venture to move the needle. Only a handful of
industries—think finance, government, health care—are large and undisrupted enough to make a
material mark on Alphabet’s top line. Conquering these markets requires huge investments for an
uncertain return, and none offers the sort of capital-light quasi-monopoly that Google has enjoyed
with search advertising.

Alphabet has two health subsidiaries (Calico for life extension and Verily for less ambitious medical
goals) and has invested around $15bn in the past six years in health-related startups. So far it has
little to show for it. And although in December Google became one of four cloud providers to be
awarded a $9bn multi-year contract with America’s Department of Defence, past attempts to enter
procurement have run into opposition from the company’s mostly progressive-leaning workers.

In finance, Google offers a digital wallet, has invested in Lending Club, a peer-to-peer lender, and
owned price-comparison sites for insurance and mortgages, which it shut down in 2016. These
efforts are unambitious compared with those of Apple, which offers a credit card and has launched
a buy-now-pay-later scheme. A bank boss with knowledge of Google’s efforts says they are
ultimately in the service of its ads business, the better to track users’ purchases, rather than a real
attempt to become a financial player.
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Alphabet’s biggest wager is in a way less ambitious. It wants to become a force in cloud-based, ai-
boosted business software. Perhaps three-quarters of Alphabet’s capital spending goes on building
and equipping new data centres. To catch up with Amazon Web Services (aws) and Microsoft
Azure, the two industry leaders, Google Cloud has in the past few years offered customers cut-price
deals. Sales have been growing at an annual rate of 40%. The unit made its first profits in the past
two quarters (albeit partly thanks to accounting changes). In a few years Google could become the
world’s second- or third-biggest provider of business software, says Thomas Kurian, who runs
Google Cloud. “Enterprises want to solve many of the same problems that consumers want to
solve,” he explains, so things that Google has been working on for years in its consumer business,
from voice recognition to ai-assisted search, offer it a leg up.

Possibly. And the enterprise business is certainly large. Firms are projected to spend more than
$3trn this year on information technology. But it is a cyclical business, and intensely competitive.
Microsoft does not break out its Azure results but operating margins at aws, which are disclosed,
have been steadily falling, from 30% or more a few years ago to 24% today.

Moreover, Amazon and, especially, Microsoft are formidable rivals. They have longstanding
relationships with corporate clients. Microsoft is already beginning to monetise generative AI in its
office software. Google, by contrast, does not have a business-to-business bone in its body. Ten
years ago Google Sheets may have been the best in the world, says a former executive. But it “failed
to wine and dine” enough chief information officers to promote the spreadsheet software.

Froogle living

With revenue growth tougher to come by, some investors think Alphabet should focus on boosting
returns by improving its overall margins. Many grumble that Alphabet shares trade at a lower price
relative to earnings than Apple or Microsoft, and not much higher than the s&p 500 index of big
American firms as a whole—a letdown for a tech pioneer (see chart 4).

In November tci, a hedge fund with a stake in the

company worth $6bn at the time, wrote a letter
to Mr Pichai demanding more discipline. It also
noted that Alphabet had too many employees—
nearly 190,000, more than twice as many as in
2017 (see chart 5)—who were paid too much.
The typical Googler takes home nearly $300,000
a year, two-thirds more than a counterpart at
Microsoft and more than twice as much as
employees of America’s 20 biggest tech firms. Its
scattershot approach to capital allocation, tci
seemed to imply, was tolerable only so long as it
was concealed by strong returns from the core
business.

Since then two other big hedge funds with an

activist streak, Pershing Square and Third Point,
have disclosed large investments in Alphabet. As
the company has grown, it has added layers of
management. “You are negotiating with vps
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and svps all day,” recalls one prominent ex-Googler. Many teams turn into mini-fiefdoms; some
managers tell employees not to take their goals too seriously. Entry-level engineers report that it is
easy to “rest and vest”—coast while waiting to cash in your stock options. And you get fed
chocolate-covered strawberries.

Some of this looseness is by design. Messrs Brin

and Page wanted to nurture a startup culture that
allowed brilliant ideas to bubble up. And they do:
one of those presented at the developers’
conference came directly from a five-person team.
But clever products often get tied up in
compliance reviews. Insiders joke that the best
way not to have your product launch is to present
it at i/o.

The upshot is that many enterprising types leave,

skewing the workforce ever more towards
engineers working for internal customers, their
managers, rather than seeking commercial
success. Notably, all eight of the researchers
behind Google’s seminal paper on “transformers”,
the computer science that gives chatbots their
wits (and the t in gpt), have since left the
company. Startups need “a tinge of desperation”
to succeed, says Aswath Damodaran of nyu Stern School of Business. By contrast, Alphabet is a
“startup business with a sugar daddy”, in the form of the deep-pocketed search operation.

One way to tackle these problems would be to reinvent Alphabet from top to bottom. Hiving off the
disparate businesses—search, YouTube, Google Cloud and so on—would, for instance, permit each
to focus resources on what it does best. Another approach would be to settle on a new direction,
rather as Apple transformed itself from a purveyor of pricey desktops to a mobile-phone behemoth
and Microsoft went from peddling software on cd-roms to cloud-computing might.

Yet a move as radical as breakup would require the blessing of Messrs Brin and Page, which is
unlikely to be forthcoming. And reinvention comes with big risks. Investors and analysts remain
deeply sceptical of Mark Zuckerberg’s bet on the metaverse. Apple and Microsoft spent years in the
wilderness before finding a second life.

And radicalism is not Mr Pichai’s style. He is clever, in an understated way, and, as befits a former
McKinsey consultant, shrewd. He has played a significant role in building the core business, which
he ran even before taking over as Alphabet’s ceo in 2019. But he is no visionary.

Mr Pichai and his lieutenants are therefore opting for incrementalism instead. He has talked about
“trying to do more with constraints”. This seems to involve gradually introducing ai features to
existing products and taking a more serious look at Alphabet’s expenses. The management astutely
used the cloud cover of the chatbot crisis to force through some needed changes. It has pulled the
plug on some Other Bets. Earlier this year Alphabet laid off 12,000 workers and merged its ai labs,
DeepMind and Google Brain, which should enable more efficient use of its ai computing power and,
if their distinct cultures don’t get in the way, its human brainpower, too. On July 25th it promoted
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Ruth Porat, its veteran finance chief, to president, as well as a new role of chief investment officer,
to steer the group’s capital allocation.

As the firm nears its quarter-century, then, it is, like a middle-aged person told to watch what they
eat more carefully, determined to get rid of the flab, eschew risky behaviour and stay disciplined. If
those efforts succeed, thinks one shareholder, Alphabet can keep increasing its bottom line even if
overall sales slow, ensuring it stays enviably profitable.

The incrementalist approach will, however, be put to the test, particularly as ai, generative and
otherwise, progresses. Engineering chops, which Alphabet clearly still possesses in spades, will not
be enough to harness the technology’s potential. That is going to require commercial ingenuity, too.
Google displayed this early on, when it developed the search-ad business model. Since then
Alphabet has, in business terms at least, mostly been able to coast on that innovation’s spectacular
success, allowing some of its commercial sinews to atrophy. If it doesn’t flex them as the age
of ai dawns, there are plenty of hungry rivals eager to muscle in.