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Alphabet (NASDAQ:GOOG) has reported strong advertising growth numbers in the recent quarter with quarterly revenue of $55 billion and YoY growth of 23% in this business. However, it is also facing tough competition due to the rise of Amazon (AMZN) in the digital advertising industry. Amazon has single-handedly broken the duopoly of Google and Facebook (FB) in the digital ad segment. This is very important for Google because the company depends heavily on the ad revenue and profits to drive growth in other segments like cloud, hardware, subscription, etc.
Amazon’s trailing twelve-month advertising revenue has soared above $30 billion and is showing a strong growth rate. It should be noted that Amazon is still relatively new to this segment and does not have the sophisticated advertising tools which Google boasts. We could see further growth in Amazon’s advertising business in the near term, putting pressure on Google’s growth. Alphabet stock is trading at a modest multiple but new headwinds in the core search business can cause bearish sentiment toward the stock.
Amazon’s entry into the advertising space has been fairly recent but the growth rate shown by the company has allowed it to build a strong revenue stream. In the last twelve months, the advertising services reported over $30 billion in revenue. The margins on this business are much higher compared to the wafer-thin margin in the e-commerce segment of Amazon. Hence, we could see more focus and resources given to the advertising business by the management.
Figure 1: Advertising revenue of Amazon in the last few quarters.
Google will need to have a strong response to the growing domination of Amazon in advertising. The main revenue and profit contributor for Google is its search services. Any headwind towards it would lead to a big negative impact on future growth of Google and its stock.
Figure 2: Bulk of revenue from Google comes from search business.
In the latest quarter, Amazon’s advertising revenue was close to 15% of the total advertising revenue of Google. Further investment by Amazon in new advertising tools and support for advertisers can create a major growth driver for this segment.
Google also needs to build an effective strategy for the changing consumer search habits within the retail segment. A report by eMarketer shows that Amazon is the default search channel while purchasing products for a significant majority of customers.
Figure 3: Amazon’s default search status for customers making digital purchases.
This trend can increase in the future as Amazon enters new product categories. Amazon is now looking to become a major player in the food delivery industry which will increase the attraction for customers to directly search on Amazon.
Google has tried to improve its own Google Shopping platform, but it is unlikely that it will be able to match Amazon within the e-commerce space. This is a long-term negative trend for Google which can lead to slower advertising growth as Amazon increases its own digital ad market share.
Amazon and Google are now competing in a number of segments like smart speakers, music streaming, subscriptions, advertising, and more. Google has used its resources and network effect to gain a massive market share within the search engine industry. However, in its battle with Amazon, Google would not have the advantage of higher resources. We have already seen Amazon invest massively in logistics, video streaming, and other businesses to deliver growth. It is likely that Amazon’s management would be ready to invest heavily to gain a bigger slice of the digital ad industry.
Figure 4: Steady increase in Amazon’s digital ad market share.
Google has an advantage in terms of its advertising tools and YouTube platform. It continues to invest heavily in AI which should give the company an edge over Amazon. Amazon could also show saturation on its platform in terms of ads shown to customers. There has been a slight decline in Amazon’s YoY ad growth rate in the recent quarter compared to over 50% growth during the pandemic.
The jury is still out over how much market share can Amazon’s advertising business take and the impact it will have on Google’s advertising business. Investors should closely follow the future growth trajectory of the ad business within these two tech giants. At the current growth trend, Google’s advertising revenue should hit $100 billion on a quarterly basis by 2025. This is a huge number which would give the company a better moat in this business. However, Amazon’s growing digital ad market share will continue to be a challenge for Google’s management. A big positive for Google is that it is aggressively trying to diversify its revenue base.
Google is a big player in smart speakers and smart home devices. It is also ramping up the Pixel production to gain a larger chunk of smartphone sales. Google has reported over 50 million subscribers on its YouTube Premium and Music platform. Google Cloud is also gaining momentum and reported $22 billion in annualized revenue rate in the recent quarter with a big improvement in operating margin.
Figure 5: Comparison of YoY revenue growth and PE ratio of Google and Amazon.
Google is facing tough competition from Amazon in advertising and many other segments. But the stock is priced modestly and there is a big improvement in the long-term diversification efforts of the management. If Google can limit Amazon’s growth in the advertising industry, it will be able to protect the core search services and also build a longer growth runway for other services.
This is the biggest challenge that Google’s management has faced in over a decade. The overall advantage is still with Google but Amazon can certainly throw a few surprises in the advertising space. Investors should closely follow the growth trajectory in the ad business for these two giants over the next few quarters to gauge the returns potential of Alphabet stock.
Google is facing a tough challenge from Amazon in the advertising segment. In the trailing twelve months, Amazon reported over $30 billion in advertising revenue. The recent quarterly ad revenue of Amazon was over 15% of Google’s search business. If Amazon continues to grab a higher market share in the digital ad business, it will limit the growth potential of Google and reduce the ability of the company to invest in other services.
Google is trying to rapidly diversify its revenue base by increasing investment in cloud, hardware, subscriptions, and other businesses. However, it will take some time before these bets make a significant chunk of Google’s revenue base. While Google’s valuation multiple is still modest compared to other giants, investors should look at the changing dynamics in the digital ad industry to gauge the long-term growth potential of Alphabet stock.
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