Alphabet Inc.’s (GOOG, Financial) (GOOGL, Financial) Google is widely regarded as one of the most innovative tech platforms in the world. It has revolutionized the fields of search, advertising, cloud computing, artificial intelligence and many others. However, the company is facing a dilemma as it tries to maintain its innovative edge while growing in size and scope.
As Google expands into new markets and domains, the company risks losing the focus and agility which enabled it to create breakthrough products and services. Moreover, the search engine operator has to mitigate the threat of increased competition from rivals such as Amazon.com Inc. (AMZN, Financial), Meta Platforms Inc. (META, Financial), Microsoft Corp. (MSFT, Financial) and Apple Inc. (AAPL, Financial) as these companies are investing heavily in innovation to challenge its dominance in several business sectors.
Toward the end of 2022, ChatGPT was launched by OenAI, which quickly gained widespread popularity. The lack of response from Google drew criticism at the time. Then, in early February, Google unveiled its AI language model, Bard, in a much-anticipated demo. Unfortunately, Bard received backlash for giving an inaccurate response to a question about a telescope. This resulted in a significant drop in Alphabet's stock price, wiping out $100 billion of its market value in a single day.
That did not discourage the company from continuing to improve the product, however. On March 21, Alphabet announced it will be allowing more people to interact with Bard as it enters the next stage of development. Google is opening a waitlist for initial applicants in the U.S. and the U.K. to use an AI tool similar to the ChatGPT technology recently deployed by Microsoft in its Bing search engine. This move comes as no surprise, given the buzz generated by ChatGPT and the potential for artificial intelligence chatbots to revolutionize the way people interact with technology. It will be interesting to see how Bard develops and expands into other countries going forward.
There is another reason to be bullish about the company, though. Alphabet's primary source of income is advertising revenue, which is earned through the Google Ads segment that allows businesses to bid on keywords and place targeted ads on its results pages. As illustrated below, Google remains the clear market leader among search engines.
Exhibit 1: Market share of search engines
Source: Statista
Over the past few quarters, ad revenue growth has been slowing down, leading to concerns about the future of the advertising market. However, with the rise of artificial intelligence, new opportunities are emerging. As such, Bard is arguably set to benefit. Using Google's large language model, LaMDA, the chat service is designed to assist users in various tasks, such as brainstorming, learning and explaining complex topics. By leveraging information from the web, Bard is being trained to provide fresh and high-quality responses to users' queries, making it a valuable addition to Google's arsenal. Bard’s ability to provide a more natural and engaging way for users to access information can help in offering more personalized ads based on user queries and preferences. This will likely help Google attract and retain new advertising clients and also increase its market share in the search engine space.
Exhibit 2: Google’s advertisement revenue
Source: Statista
The global digital advertising industry has also been impacted by inflation. As businesses face higher costs, they are often forced to cut back on their advertising budgets to maintain profitability. This has led to a decrease in overall ad spending and a shift toward more cost-effective advertising strategies. Another significant factor contributing to the slowdown in ad spending growth is the ongoing conflict between Russia and Ukraine. This conflict has caused many European businesses to become hesitant about investing in advertising due to political instability and economic uncertainty. As a result, many businesses are choosing to cut back on their advertising budgets until the situation stabilizes.
Despite these challenges, the digital advertising industry remains a critical part of the global economy, with businesses of all sizes relying on digital ads to reach customers and promote their products and services. According to a report by Insider Intelligence, digital ad spending growth is expected to reach 10.5% in 2023.
Although it had a lackluster fourth-quarter 2022 earnings report that missed both earnings and revenue expectations, Alphabet's established business moat remains a strong foothold in the tech industry. While a slowdown in YouTube advertising revenue and higher operating expenses caused the company's poor financial performance, Google Cloud continued to exhibit strong growth, with revenue up 32% to $7.32 billion and operating losses narrowing to $480 million.
Alphabet's investments in innovation, such as its deal with the NFL for YouTube's Sunday Ticket rights and the growth of YouTube Shorts, demonstrate its commitment to long-term profitable growth. According to a Pew Research Survey in 2021, YouTube is the most used social media platform in the U.S., with the platform widely popular across all age categories. This makes it a top advertising platform for many businesses.
While disruptive forces such as advancements in artificial intelligence pose a threat to Alphabet's market dominance, the company's moats around its core search product, including Android, Google Maps, YouTube, Gmail, Chrome and the Google Play Store, create a significant challenge for any competitor seeking to dethrone it. As the company works to re-engineer its cost structure and deliver long-term profitable growth across the company ecosystem, Alphabet remains a force to be reckoned with.
Takeaway
As the AI revolution continues to disrupt various industries, concerns have been raised about its potential impact on Alphabet's businesses, particularly its dominant position in the search engine market. Despite competitive threats, the company is well positioned to maintain its market leadership, aided by substantial investments and its massive reach.
To maintain its competitive edge, the company has invested in Bard and other AI-powered products. With its natural language responses and personalized content, Bard has shown significant promise as a tool for Alphabet to enhance its position in the search engine market and continue to drive artificial intelligence innovation. While the current downturn in the advertising market has impacted revenue, investors with a long-term perspective are likely to find the company an attractive bet as its long-term earnings power remains stronger than ever.
