„Competition is not only the life of trade, it is the trade of life”
– The Lessons of History by Will & Ariel Durant
arvy’s teaser: Alphabet (Google) dominates the ad world, but rising competition and the emergence of AI challengers like OpenAI’s Chat GPT are rewriting the rules. It faces a pivotal moment. Can Alphabet’s relentless innovation sustain its edge, or will disruption force a new era?
Ads.
It is a love-hate relationship.
On the one hand, you are annoyed because it interrupts the video you are watching, the story marathon on Instagram or your favorite TV show. On the other hand, you love clicking on the ads that are perfectly tailored to your interests thanks to the algorithm. After all, you want to keep up to date with the latest trends, be it a few chic clothes or that trip to Bali that suddenly pops up after discussing it with a group of friends😉.
The advertising market is in the hands of a few very dominant players. Think about yourself: Where do you see most ads? When scrolling through social media (Meta), buying books (Amazon), watching videos (YouTube) or googling.
The latter two are controlled by the true market leader in advertising (chart 1).
The parent holding company of Google.
Alphabet.
Chart 1: Where is advertising spend going, growth rates and scale of advertising revenue
Source: Quartr
A Conglomerate of Stellar Businesses
It all started as a small company in a garage in 1998.
Along the way, Alphabet has helped shape the tech industry. From almost being acquired by Yahoo (if you know Yahoo, you realize you are not Gen Z😉) for $1 million in 1998, to refusing to be bought by Yahoo four years later for $3 billion, to creating a much-copied company culture and major initiatives like the “20% Time” policy that has led to remarkable experimentation and entrepreneurial thinking.
The latter in short, Google’s “20% time” policy allows employees to spend one day a week working on personal projects to encourage innovation and creativity alongside their regular duties.
This is how Gmail came about.
Fast forward to today, Alphabet is the fourth largest company in the world with a market capitalization of $2 trillion. It has developed into a conglomerate of stellar businesses impacting almost every aspect of modern life (chart 2).
With solutions ranging from advertising to cloud computing and self-driving cars, Alphabet has become a true technology behemoth, generating a net profit of $2.8 for every $10 in revenue, which equates to a net margin of 28%. In a single quarter, this resulted in a net profit of $23.6 billion.
That is about as much as the 20 largest Swiss companies generate combined.
Wow!
The rising star in its business segments is Google Cloud, with growth rates of 29% compared to 14% for the company as a whole. The growth of this segment strengthens Google’s overall position as it taps into the high-demand public cloud market, helps companies digitize their workloads and diversifies its business away from Google Search.
Good timing for Alphabet, because as we know…
… every good story has a villain.
Chart 2: Alphabet Revenue Breakdown, Q2 2024, last twelve months
Source: Quartr
OpenAI’s Chat GPT
We are book lovers, as you know.
One of our favorite books and a previous Christmas present was “The Lessons of History by Will & Ariel Durant”. It is a 130-page summary of 5,000 years of history.
What has stuck with us ever since is the fact that the authors argue that extreme historical events such as pandemics, world wars and other catastrophic circumstances lead to profound and often drastic changes in society’s consumer behavior.
Just think of the Covid pandemic four years ago – yes, four years already, time is ticking.
Since then, we have seen an enormous acceleration in technological trends, be it the emergence of home office, web calls, digitization, but also the way we behave in our daily lives.
As far as Google Search is concerned, the villain entered the room a little later in November 2022.
Chat GPT.
Alphabet’s core strategy is to maintain its strong advertising business, with most advertising revenue coming from Google Search (57% of group revenue). To this end, the company has invested heavily in improving its search capabilities over the years to ensure that its search engine remains deeply embedded in the way hundreds of millions of users access information on the internet.
But these heavy investments are now meeting a new way of searching for information – a possible shift in society’s behavior, which is now much more willing to try out new tech trends as Covid has been an accelerator.
The Chat GPT App – I can simply pull out my phone, speak into it effortlessly and get a clear analysis of last weekend’s election results in Switzerland, for example, or a perfect weekend trip to Paris.
The highlight?
All for free and without enduring a single ad!
Not only do I get a precise, convenient and very well-tailored answer to my questions – okay, not always 100% correct – but I also avoid googling. This hits Alphabet’s advertising revenue hard, because I bypass the ads that appear under my search query.
Is this the reason for the company’s lowest valuation in years?
Chart 3: arvy’s book club: The Lessons of History by Will & Ariel Durant
Source: arvy’s book club
Competition is Good for Business
Alphabet may be trying to diversify its business away from search, but text-based advertising is still the largest contributor to the company’s revenue, which poses a concentration risk.
Google Cloud or other smaller segments will not be able to offset such a threat anytime soon.
This is what market participants are already sensing and factoring into Alphabet’s valuation, alongside the never-ending regulatory pressure on its search dominance.
But as Alphabet has proven repeatedly, its corporate culture and entrepreneurial spirit has enabled it to thrive in an incredibly competitive environment and stay at the front of the race.
Therefore, the benefit of the doubt remains with Alphabet for now, and I would like to end this Weekly with a philosophical note from Will & Ariel Durant.
Competition is not only the life of trade.
It is the trade of life.
Chart 4: Alphabet over the last ten years
Source: TradingView
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