Good morning,

Yesterday I wrote an Article about Intel’s Humbling, covering not just the company’s earnings and deal with UMC, but also why I’m optimistic the company is headed in a better direction.

Meanwhile, on yesterday’s Sharp Tech we explored the implications of Apple’s response to the E.U.’s Digital Markets Act.

On to the Update:

Google Earnings

From Bloomberg:

Alphabet Inc. reported fourth-quarter revenue from its core search advertising business that fell short of analysts’ estimates, overshadowing an otherwise strong end to the year. Sales, excluding partner payouts, jumped 15% to $72.3 billion in the three months ended Dec. 31, the company said Tuesday in a statement. That was better than the $71 billion analysts had projected, and the best quarter for revenue growth in seven. Net income was $1.64 per share, compared with Wall Street’s estimate of $1.59 per share.

But revenue in Alphabet’s core search business was $48 billion, narrowly missing analysts’ projections for $48.15 billion. The shares fell 6.5% in extended trading. The disappointing results come at a time of broader uncertainty for Google’s search engine, which has dominated the global internet for years and is the subject of a major antitrust case. Its leading position is threatened by new competition as the rise of generative AI has enabled companies like Microsoft Corp. and OpenAI to deliver programs that answer users’ questions in a more conversational fashion, like the wildly popular chatbot ChatGPT.

Google first broke out YouTube revenue — which accelerated to 16% growth (a good sign for Meta) — from the rest of Google Sites revenue (which is primarily search) in Q4 2018. This is what revenue and growth rates look like since then:

First off, search revenue is not in nearly the doldrums it was a year ago (some of which, to be fair, was a matter of difficult COVID comps). What has happened is that the recovery in growth that seemed to be happening the last few quarters from last year’s nadir has slowed. This does not mean that things like AI — to take the chief worry about Google search, both in terms of customers using alternatives to search and also cannibalizing the search experience itself — are or are not having an effect; the only thing one can be sure about is that it does not appear to be helping. That, frankly, is as far as I’m willing to go: there simply isn’t enough data or commentary from management to say more than that about a subject so fraught.

That noted, there were three interesting tidbits about generative AI and its impact on search that I noted on the earnings call. First, CEO Sundar Pichai was explicitly asked if Google had seen decreased search queries, and he completely dodged the question:

Thanks, Justin. First of all, look, we think about effects on Search, obviously, more broadly. People have a lot of information choices, and user expectations are constantly evolving. And so we’ve been doing this for a long time. And I think what ends up mattering is a strong continuous track record of innovation. Obviously, generative AI is a new tool in the arsenal. But there’s a lot more that goes into Search: the breadth, the depth the diversity across verticals, stability to follow through getting actually access to rich, diverse sources of content on the web and putting it all together in a compelling way. And I think, through the year too, when we test, we test Search Generative Experience, particularly against everything that’s out there. And we can see the progress we are making and how much users are liking the experience better. And so I think I feel very good about the progress. And our road map for ’24 is strong both on the Search and the underlying AI progress, including the model. So I’m pretty excited about what’s ahead of us in ’24.

That certainly suggests the answer might be yes?

The second bit was around those “Search Generative Experiences” (SGE), where Google generates an answer to your query at the top of the search results page. CBO Philipp Schindler said in his prepared remarks:

As we shared last quarter, ads will continue to play an important role in the new search experience, and we’ll continue to experiment with new formats native to SGE. SGE is creating new opportunities for us to improve commercial journeys for people by showing relevant ads alongside search results. We’ve also found that people are finding ads either above or below the AI-powered overview helpful as they provide useful options for people to take action and connect with businesses.

Google’s big hope is that SGE keeps Google users on Search and still monetizes as well as 10 blue links.

The final bit was Bard: Pichai said in his opening remarks:

Then there is Bard, our conversational AI tool that complements search. It’s now powered by Gemini Pro and is much more capable at things like understanding, summarizing, reasoning, coding and planning. It’s now in over 40 languages and over 230 countries around the world. Looking ahead, we’ll be rolling out an even more advanced version for subscribers powered by Gemini Ultra.

And that was pretty much it. I only mention Bard because it seems pretty clear that Google is putting all of its weight behind making SGE work, and I think that makes sense. That is the channel and the habit that Google owns, and its best defense against the likes of ChatGPT is to not give users any reason to change their habits.

Google Cloud

Last quarter I was concerned that Google Cloud revenue growth had slowed significantly, even as margin shrunk; this quarter was much more encouraging on both fronts, as growth re-accelerated and margin leaped to its highest mark ever:

Google Cloud	Revenue	Growth	Loss	Margin
Q4 2019	$2,614		$(1,194)	-46%
Q1 2020	$2,777		$(1,730)	-62%
Q2 2020	$3,007		$(1,426)	-47%
Q3 2020	$3,444		$(1,208)	-35%
Q4 2020	$3,831	47%	$(1,243)	-32%
Q1 2021	$4,047	46%	$(974)	-24%
Q2 2021	$4,628	54%	$(591)	-13%
Q3 2021	$4,990	45%	$(644)	-13%
Q4 2021	$5,541	45%	$(890)	-16%
Q1 2022	$5,821	44%	$(931)	-16%
Q2 2022	$6,276	36%	$(858)	-14%
Q3 2022	$6,868	38%	$(699)	-10%
Q4 2022	$7,315	32%	$(186)	-3%
Q1 2023	$7,454	28%	$191	3%
Q2 2023	$8,031	28%	$395	5%
Q3 2023	$8,411	22%	$266	3%
Q4 2024	$9,192	26%	$864	9%

So what happened? Well, once again, who knows. An analyst asked about this yo-yo explicitly, but unfortunately put words in Pichai’s mouth which he leveraged to really not answer the question:

On Cloud first, there’s just this volatility, this material deceleration last quarter and the nice reacceleration this quarter. Is that explained by where we are in the optimization cycle, and it may be generative AI workloads starting to trickle in now and cause that growth curve to bend back up? Any commentary just on the sort of the volatility, the deceleration and the reacceleration that we’ve seen?

SP: First of all, a combination of factors. I think definitely excitement around the AI solutions on top of our foundational pillar with data and analytics, infrastructure, security, et cetera. But AI is definitely something which is driving interest and early adoption. And as you saw, that greater than 70% of Gen AI unicorns are using Google Cloud. And so I think it’s an area where our strengths will continue to play out as we go through ’24, especially when I look at innovation ahead from us on the AI front. And second, I think there are regional variations, but the cost optimizations in many parts are something we have mostly worked through. And I think that was a contributing factor as well.

CFO Ruth Porat also referenced AI in her prepared remarks, but also added a pertinent tidbit:

Turning to the Google Cloud segment. Revenues were $9.2 billion for the quarter, up 26%. We’re very pleased with the momentum of GCP with an increasing contribution from AI. Google Workspace also delivered strong revenue growth, primarily driven by increases in average revenue per seat.

An “increase[] in average revenue per seat” sounds like a price hike, and indeed, note this announcement last February:

We are increasing the price of Flexible Plan subscriptions. Flexible Plans offer customers the option to pay as they go, with no commitment, and provide customers the option to add or delete user accounts at any time, offering added flexibility for businesses with a variable-size workforce…

We are increasing the price of Google Workspace Enterprise Standard to reflect the value we’ve added to the edition, including industry-leading security controls and administrative features designed for large enterprises. There are no list price changes to the other Enterprise editions, including education upgrades. Customers should connect with their account managers if they have questions.

To give our existing partners and customers sufficient lead time, the new pricing will roll out starting in April of this year and through 2024, depending on factors that include number of user licenses, current contract terms, and payment plan. For example, pricing for existing Google Workspace subscriptions with 10 or fewer user licenses will not change until January 2024. Customers will be notified via the Google Workspace Admin Console at least 30 days before their price changes take effect and provided with more specific information to help them navigate these changes.

The Flexible Plans increased 20% for new users early last year, while the enterprise price increase wasn’t clear in terms of either magnitude or timing; it certainly seems a lot of those price hikes kicked in last quarter, though.

The broader takeaway is this: back when Google IPO’d it offered a lot of interesting data about its business. The information about the change in cost-per-click, for example, arguably harmed the company — investors who didn’t understand the Internet were appalled that it kept decreasing — while also providing tremendous insight: one of my core understandings about Internet business models was appreciating that a decreasing cost-per-click was actually a good thing for an Aggregator.

Over time, though, it feels like Google has become more inscrutable, and that inscrutability feels like it has accelerated over the last few years. The company still doesn’t properly break out YouTube’s financials, in my opinion — SEC law says that segments that report to the CEO have to report profit and loss, but Google only reports revenue — but the more frustrating bit from my perspective has been recent earnings calls. There is the bare minimum of information given — usually by Porat — and nearly every question from analysts is dodged or ignored. I should note that I’m obviously incredibly biased in this regard — I want more information to do my job — but it doesn’t feel very confidence-inspiring.

Microsoft Earnings

Again from Bloomberg:

Microsoft Corp. posted its strongest revenue growth since 2022, spurred by interest in new artificial intelligence products that in turn are driving renewed spending on cloud computing. Revenue in the second quarter, which ended Dec. 31, rose 18% to $62 billion, while profit was $2.93 a share, the company said in a statement Tuesday. Analysts polled by Bloomberg on average estimated per-share earnings of $2.78 on sales of $61.1 billion.

Azure cloud-services sales gained 30%, compared with 29% growth in the previous quarter. That exceeded the 28% growth analysts projected. In a call with analysts, the company said growth in the Azure division would “remain stable” during the current quarter. In an interview, Chief Financial Officer Amy Hood said AI boosted Azure’s growth rate by six percentage points. Going forward, she said, interest in AI products will prompt customers to step up their use of such basic services as storage and computing power. “We want to be the place where people can most confidently come to run AI models,” Hood said.

Last quarter I highlighted how AI was propelling Azure to higher growth rates than Google Cloud, even off of a bigger base; that continued this quarter, and is certainly a mark in Microsoft’s favor.

At the same time, six points of AI growth means that the non-AI parts of Azure only grew 24%; that’s less than Google’s 26% (which again, includes Workspace price increases, so maybe it’s comparable). Moreover, that’s a slowdown from last quarter, when Azure ex-AI grew 26%.

There is another point that I should mention as well: recall that Microsoft’s investments into OpenAI are structured as Azure credits; OpenAI then turns around and spends those credits on Azure, which are counted as revenue. So, in a certain respect, some amount of that Azure AI growth is simply Microsoft passing money from one hand to the other. I don’t think this is some big scandal (although I would welcome reader’s assistance in figuring out where, if anywhere, the exact amount of credits outstanding and/or spent are in Microsoft’s 10-Q — I couldn’t find them) because the usage is real, whether it be via ChatGPT, OpenAI’s API, or OpenAI itself.

What is interesting, though, is how these costs are recorded: usually spending on developing AI would fall under R&D, and running ChatGPT would fall under cost of goods solds; the latter would impact gross margin and the former net margin (because there would be no corresponding revenue increase). For Microsoft, though, the cost is in investing activities — below the line as far as net profit is concerned.

One other note: there is a new line in the risk factor “Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business.”

Before:

…If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones, as well as acquired companies’ ability to meet our policies and processes in areas such as data governance, privacy, and cybersecurity…

After:

…If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. We also have limited ability to control or influence third parties with whom we have arrangements, which may impact our ability to realize the anticipated benefits. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones, as well as acquired companies’ ability to meet our policies and processes in areas such as data governance, privacy, and cybersecurity…

Now there’s one place where OpenAI shows up in the 10-Q!

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