If you didn’t read the original post, we’ll briefly recap for some context.
Alphabet makes money in two main ways:
Starting with advertising, there are two distribution methods:
AdWords (aka Properties) - these are the ads you see when you do a Google search or watch YouTube videos.
AdSense (aka Network Members’ Properties) - you see these ads on highly-trafficked websites. (You know, the ones that disallow news websites from loading…)
The “Other Stuff” includes a bunch of things including:
GCP (Google Cloud Platform - the company started breaking this out specifically)
YouTube TV and YouTube Premium
Advertising still accounts for 83% of Alphabet’s overall revenue. Drilling further, Properties makes up 70% of revenue and Network contributes the remaining 13% towards advertising.
Moving on, in the last quarter of 2019, Alphabet released some very interesting data points.
For starters, it broke out YouTube ads for the first time ever. It now does more than $15 billion in revenue, excluding YouTube TV/Premium.
Second, it more clearly broke out Google Cloud, which is now almost a $9 billion revenue segment.
Lastly, another interesting data point, or rather, the exclusion of data, was the TAC (traffic acquisition cost). For a long, long time the company has disclosed the percentage of revenue paid to partners but this time, it only reported total TAC.
[To be clear, Google pays the website publishers on the Network side and browsers/smartphone OEMs (original equipment manufacturers) like Apple to be the default search engine on the Properties side.]
For example, this is from the Q1 2015 earnings release and this same chart has been included in every release until Q4 2019.
Now this isn’t unethical or anything, it’s Alphabet choice whether to disclose this information; however, it’s peculiar.
Before moving on, notice how much higher Google’s Network pay-outs are than on the Properties side.
68% vs. 8% in 2014/15
This is because Google doesn’t own the underlying websites and therefore, has to pay the publishers a reasonable rate. However, the 8% of total Properties/Website revenue as TAC is really interesting.
Remember, for Properties, Google pays browsers and mobile carriers/manufacturers to be the default search engine. This is the cost of providing the service rather than paying a particular publisher. Think about it, when you do a Google search and you see the ads at the top, the publishers are paying Google for digital real estate rather than the other way around. This is why Google Properties (read: AdWords) is one of the best business models of all time. It’s literally a digital real estate empire, charging rent to companies to acquire customers.
What’s interesting, though, is that traffic acquisition costs as a percentage of Properties revenue have gradually increased over the past 5 years. On the other hand, Network pay-outs have stayed relatively flat.
I mean, here’s the thing: Properties now does $114 billion in revenue at 86% gross margins. Boo-hoo, it no longer has 92% gross margins. I don’t think it’s a big deal but it highlights something important.
To keep TAC low, Google’s strategy has been to corral EVERY way that people approach the internet.
For instance, did you think Chrome was just some altruistic browser that made your life easier?
Nope, the higher market share Chrome has, the less money Google has to pay-out to Firefox/Brave/Internet Explorer (is that still a thing?)
Or how about Android? Why do you think they are so cheap?
Again, it’s not altruism, it’s an ingenious way to keep TAC low, thereby leveraging a huge user base against advertisers.
The more portals to the internet that Google controls, the less is will have to pay in TAC.
Google Properties is one of the best businesses ever created. Next time you see Google creating an awesome new capability or product, it is likely protecting this moat. I can’t think of another business that can do anywhere close to $100 billion in gross profit on $114 billion in revenue.
However, as we saw, TAC as a percentage of Properties revenue is rising and Google stopped breaking out the metrics for the first time. That’s not a coincidence.
Apple is likely the main culprit here. Reports estimate that Google paid Apple $12 billion last year for the right to remain the default search engine. That is 75% of Google’s $16 billion in Properties TAC.
It’s interesting to see who really has the power here. On one hand, Apple has sold 1 billion iPhones cumulatively and is a huge portal to the internet. On the other hand, Google’s search engine is so much better than competitors that if Google' didn’t pay Apple, would that really make a huge difference? Apparently, Google thinks so or else it wouldn’t cough up $12 billion.
The winner? Likely Apple or else Google’s Properties TAC wouldn’t be growing faster than revenue.
Don’t get me wrong, Google is NOT struggling. It’s just interesting to see how Google’s products make sense in this entire context.
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