Two Years After Google Became Alphabet, These 10 Numbers Are Its Report Card

Those bets on the future haven't paid off yet.

On August 10, 2015, Google announced a restructuring plan and renamed the whole company Alphabet.

The new name works two ways: the alphabet, and "alpha bet" — a big wager. Alphabet is a collection of companies, and Google became one part of it. Sitting alongside Google is a set of wholly owned subsidiaries with a futuristic cast, the bets beyond Google: smart homes, self-driving cars, life sciences and more. Each has its own CEO and answers for its own profit and loss.

"Google is not a conventional company, and we don't want it to become one," Google co-founder Larry Page wrote in a public letter explaining the purpose of the restructuring.

Google is becoming conventional anyway. Search advertising left over from the PC era props up a market capitalization of more than 600 billion dollars and makes Google one of the most valuable companies in the world.

Its problem looks a lot like Baidu's.

Google, of course, hasn't slid the way Baidu has, has had no medical-advertising scandal, and runs a far richer set of businesses.

But the most important business at both companies — advertising — faces the same trouble. On a smartphone, users open an app directly instead of searching. Social networks have replaced search as the first gateway.

Today Baidu's revenue is a fraction of Tencent's. Facebook's ad revenue is still smaller than Google's, but it is growing more than twice as fast.

After several failed tries at building a social network, Google losing its advertising lead to Facebook is only a matter of time. Alphabet exists to find room to grow outside advertising.

Whether out of personal curiosity or in search of a future for the company, Google's three founders have tried all sorts of odd experiments: balloons sent into the sky to beam down internet access, smart glasses, even drugs to extend human life.

The reorganization is an experiment too. Google split off its innovative businesses and let each one develop on its own turf, looking for a future beyond advertising.

Two years on, has Alphabet reached that original vision? These ten numbers tell the story.

Two years after the reorg, the stock market likes Google more

+42%

Alphabet's share-price gain over two years.

The restructuring solved something that had bothered investors for years: Google used to fold the results of its new businesses in with everything else and disclosed little about its frontier ventures. After the split, Alphabet made those once-secret numbers public, which let more people see how big the new businesses really were.

Wall Street's response to Alphabet was warm — when the restructuring was announced two years ago, Google's market value rose by 26 billion dollars within hours.

Two years later, Alphabet's stock is up 42%, its market value has climbed from 454.6 billion dollars to 651.5 billion dollars, and along the way it briefly passed Apple to become the most valuable company in the world.

The Nasdaq Composite rose 26.5% over the same stretch and the S&P 500 less than 20%, so Alphabet beat the market.

That is one of the good effects of the restructuring.

The result is mixed, though. Looking only at the share price, Alphabet's two-year gain was the fourth best among the world's five largest tech companies — behind Amazon, Microsoft and Facebook, and only slightly ahead of Apple.

Apple, which suffered a drop in both revenue and profit, has only recently begun a slow recovery from the iPhone 6s slump.

The market also likes Google because it is willing to share profits with investors

6.438

billion dollars

The profit Alphabet has spent buying back its own stock

There is another reason the stock rose: after the restructuring, Alphabet started buying back its shares.

Before the reorganization, Google never used its profits to reward shareholders. No dividends, no buybacks.

In May 2015, Google hired Ruth Porat, formerly of Morgan Stanley, as its new chief financial officer. She drove the creation of Alphabet, and at the same time gradually brought the company around to Wall Street's rules.

In October 2015, two months after Alphabet was formed, it announced a 5.099-billion-dollar buyback — the first in Google's history. The following March it added another 514,000 shares.

By June this year, Alphabet had spent 6.438 billion dollars buying back stock.

Buybacks cut the supply of shares in circulation and raise net earnings per share, which pushes the price up. It amounts to a company spending its profits to buy a higher share price. Two years on, it has worked.

Look at the Other Bets, though — Google's various wagers on the future — and the picture is far less cheerful.

Layoffs, reshuffles, even shutdowns: the future projects are quieter than promised

+2

companies

How many subsidiaries Alphabet has added.

Alphabet started with 8 companies.

Google is still the biggest of them, and Search, YouTube, Android, Maps and the rest are all still inside it.

New businesses that had been scattered around Google were split out: the smart-home company Nest, the longevity-drug outfit Calico, the smart-city company Sidewalk, the secretive product research lab X, the high-speed fiber broadband business Fiber, and two venture capital firms.

These companies either came out of past Google acquisitions or broke away from X.

If you are betting on the future, more future projects would seem to be better. In fact, Other Bets has grown by only two companies in two years.

A month after the restructuring was announced, Alphabet added Life Sciences to work on life-science research; it was renamed Verily at the end of 2015 and raised an 800-million-dollar Series A from Temasek in early 2017.

In December 2016, the self-driving car project that had belonged to Google X was split out as well, becoming a company called Waymo.

Alphabet has also arranged outside partnerships to push these companies toward commercialization. Last August, Verily set up a joint venture with the British drugmaker GlaxoSmithKline to treat disease by capturing the body's electrical signals. A month later it announced another joint venture, with the French drugmaker Sanofi, this one on diabetes.

More companies will appear. In an open letter to investors this April, Page said he would keep "looking for stunning, underdeveloped opportunities and making them real."

Judging by how they are running, each of the nine Other Bets companies has its own revenue pressure, but none has closed its doors.

Most of them, though, have been through changes of staff and strategy.

Last March, reports said the smart-home subsidiary Nest was selling fewer products than Alphabet expected; three months later its CEO resigned, and new products came slowly after that. Google's own smart speaker has now stolen Nest's thunder.

The telecom subsidiary Access was once the Other Bet most likely to make money first, but its high-speed internet project, Fiber, later cut staff heavily and went through three CEOs, the last of whom left a month ago. Google's push into the broadband carrier market has since moved to Project Fi, under X.

The self-driving car project has given up on building cars, too. Since becoming independent, Waymo has concentrated on a self-driving operating system. Nearly every executive who joined the driverless project at the start has left Alphabet. The project "graduated" in a hurry, dropped the idea of making its own cars, and went to work with Fiat Chrysler, one of the weaker carmakers technically.

Some projects show no path to profit any time soon. Calico, the drug company trying to extend human life, puts its own timetable for a new drug at 20 years out.

Merely surviving counts as luck. Plenty of frontier projects inside Google and X lost Alphabet's backing once they failed to commercialize; what waited for them was shrinking, a pivot or the axe.

The robotics company Boston Dynamics was bought while Andy Rubin, the father of Android, was still at Google. After Rubin left, Boston Dynamics was moved under Google X. Its robots became internet celebrities and appeared in public a few times, but profit stayed far off, and in June Google sold the company to SoftBank.

Early last year Mike Cassidy, who ran the high-altitude balloon Wi-Fi project Project Loon, left; his successor, Tom Moore, left this March. Last November the drone project's executive David Vos and his boss Sean Mullaney resigned together.

ATAP, another frontier product group, has changed shape as well. Its head, Regina Dugan, was hired away by Facebook, and the modular phone it had worked on for three years was killed.

This is only part of the turmoil. In the financial numbers, Alphabet's bets look worse still.

The bets on the future are still burning cash

-3.6

billion dollars

Alphabet's losses outside Google in one year.

After the restructuring, Alphabet began putting the revenue and losses from outside Google into its earnings reports, splitting the financials in two — advertising and Other Bets — and no longer shielding these cash-burning frontier projects from view.

In the second quarter this year, that side lost 772 million dollars from operations, bringing its losses over 12 months to 3.6 billion dollars. In two years Alphabet has spent more than 7 billion dollars on non-advertising businesses, equal to 18% of its total net profit.

The good news is that the losses are shrinking. On the earnings call the CFO pointed out that Nest brought in 284 million dollars in revenue and that Fiber's losses narrowed by 100 million dollars.

That is Ruth Porat's doing. Losing money forever should not be normal, and after the restructuring she cut costs across the company, from tighter hiring targets to trimming the free meals Google employees once bragged about.

Frontier projects that don't earn get cut. At this year's ReCode conference, Porat described how Google makes that call internally: the frontier projects are reviewed week by week, with Porat leading a team that assesses each one in full and then reports to Sergey Brin and Larry Page.

The question the two founders ask most often is: "How will these bets help us grow?" What Porat does is add up every cost, including employee equity, put the numbers in front of the founders, and let them decide whether to kill the business.

Alphabet is still an advertising company

87%

is advertising

Advertising's share of Alphabet's total revenue.

The companies that remain are kept alive by advertising.

In the latest earnings report, Google's ad revenue reached 22.672 billion dollars, up 18% from a year earlier — another record.

That is 87% of total revenue, 3 percentage points lower than two years ago. The decline is small, but it does show Google leaning slightly less on advertising.

Since it was founded in 1998, Google's main revenue has always been advertising: provide free, useful internet services, collect information about users, then show them precisely targeted ads.

But Google's ad business expanded on the back of a fast-growing internet population. That population dividend is gone, the PC era ended long ago, and the ad money Google extracts from each user has barely moved.

Google's format of advertising may be a poor fit for phones by nature. Search a popular keyword such as car insurance on Google and half of the first screen on your phone is ads labeled "AD." For someone who just wants an answer fast, that many ads spoil the experience.

The whole point of building Alphabet was to free Google from advertising and find new revenue in new businesses.

Two years later, advertising's dominance has not eased. Its share of revenue has stayed near 90% the entire time.

Future growth is expected to come from advertising as well. Google added a news feed to its search app, said to surface automatically the news you care about — and that created new ad slots.

Baidu, China's largest search company, did exactly the same thing. By the second quarter this year Baidu's ad revenue grew 5.6%, ending four straight quarters of decline.

Meanwhile, what Google pays for its advertising keeps rising.

Alphabet still has to buy ad traffic with its profits

22%

The share of total revenue spent buying traffic.

Revenue rose, yet Alphabet's stock fell 3% after this quarter's earnings, while its rival Facebook rose 3.7% over the same days.

Facebook's ad business is only a third the size of Google's, but it is growing much faster: its ad revenue jumped 47% this quarter, far ahead of Google's 18%.

87% of Facebook's ad revenue comes from its own mobile products, with desktop a small sliver. Google's ad business as a whole grew just 18%.

One reason may be that Facebook has essentially no cost of acquiring traffic. The friends and family users care about are already there, so Facebook doesn't pay a cent for that enormous audience.

Google spent 5.09 billion dollars on traffic acquisition costs alone, about 22% of total revenue.

That money pays revenue shares to the websites and apps in its ad network, plus fees to be the default search engine inside certain software — the default search on Apple's iOS, third-party browsers and so on.

Last April, Alphabet CFO Ruth Porat said on an earnings call that Google's traffic acquisition costs on phones are even higher than on PCs.

Chrome once brought Google free traffic. On phones, the iPhone defaults to Safari and Android requires sharing revenue with handset makers.

The time people spend on smartphones goes into all kinds of apps and games, and the partner websites that used to send ad traffic to Google keep dwindling.

YouTube, advertising's new hope, remains a mystery

???

YouTube's total ad revenue, which Google has never disclosed.

YouTube may be the business closest to money outside search.

July's earnings showed Google's ad business up 21%, and on the call Ruth Porat confirmed that the biggest contributors to that growth were mobile search and YouTube.

YouTube is already the largest internet television service in the world, and compared with a search box it has more possible ways to make money. Google has tried several: a deal with more than 40 cable channels, including Fox, ABC, CBS and NBC, to launch an internet TV service for 35 dollars a month;

and YouTube Red, which started at the end of 2015 and lets users pay 9.9 dollars a month to watch exclusive content from popular creators and skip pre-roll ads.

Google has never released YouTube's standalone results. eMarketer estimates YouTube's revenue last year at 5.18 billion dollars, up 20% from 2015.

UBS analyst Eric Sheridan is more bullish. He puts YouTube's revenue last year above 10 billion dollars and expects 21% annual growth for the next four years, reaching 27.4 billion dollars by 2020 — roughly Facebook's entire revenue in 2016.

That is a forecast, though, and YouTube today is not that big. According to the post-earnings call, YouTube has 1.5 billion monthly active users, each watching about an hour of video a day.

With a user base that large, the advertising numbers still can't be made public. Before the earnings came out, most observers expected Google to disclose YouTube's results at last. They never appeared.

Under the rules of the U.S. Securities and Exchange Commission, a business must publish its figures in the earnings report once its revenue, profit or assets exceed 10% of the company's total. Google's silence about YouTube means the video site clears none of those three bars.

YouTube Red, the object of such high hopes, looks like a contradiction in itself.

YouTube grew out of what users uploaded, and professional video has never been its strength. Uploads by users tend to be short and not especially deep, so asking people to pay for them is a little strange.

YouTube knows this. Instead of buying rights to raise the quality, it has leaned on creators who are already famous, asking them to join YouTube Red and make somewhat more polished videos.

The trouble is that these creators drew huge followings precisely because their videos were free. Once a creator starts charging, the audience inevitably shrinks. Creators who stay free fall outside the paid tier, and creators who go paid risk losing their influence.

Advertisers won't be happy to see large numbers of users pay to block ads either. The people willing to pay for content are exactly the valuable users advertisers want.

YouTube Red is indeed not doing well. The last subscriber number came out in November last year: in its first year the paid service had drawn only 1.5 million people, 2% of YouTube's users. YouTube executives recently confirmed that YouTube Red will merge with Google Play Music into a new platform to attract users.

Governments have begun restricting the kinds of ads Google can run

2.7

billion dollars

The enormous fine the EU recently handed Google.

Government pressure is another drag on Google's ad revenue.

On June 27 this year, the European Commission fined Google 2.42 billion euros (about 2.7 billion dollars) for unfair competition.

The conflict came out of Google's product-recommendation feature: search for a product name and the results page pops up a box with the product's picture and price. The EU concluded that Google was using its near-monopoly in search to steer shopping links to its own service.

Google has more than 90 billion dollars in cash on its books, so 2.7 billion doesn't look like much. It still hurt the numbers: the sum equals about a third of Alphabet's quarterly profit.

On the day the fine was announced Alphabet's stock fell nearly 3%, erasing 17 billion dollars in market value.

Alphabet's net profit fell in the second quarter, and the earnings report blamed the EU fine, with the 2.7 billion dollars booked under "other current liabilities." The fine affected paid ad clicks too: from the second quarter of 2016 to the second quarter of 2017, Google's total paid clicks fell 23%.

The case sets a bad precedent for innovation in Google's ad business.

The EU, from a position of strength, defined for Google what advertising is, ruling that recommending products inside search results is monopolistic.

Google has been steadily adding product recommendations, travel booking and similar features to its results pages and taking a cut of the orders it sends to merchants. If it cannot change the minds of governments around the world, that will damage an important new source of revenue in mobile advertising.

The smartphone hardware business is off to a bad start

240

days

How long it took Google's Pixel to go from zero to 1 million units sold.

Google has never stopped hunting for revenue outside advertising.

It had been releasing Nexus phones since 2010, but they arrived as "Android reference designs": partner manufacturers designed the hardware and Google controlled the software.

The Pixel is not another Nexus. This time Google stressed that it designed the hardware itself, with the manufacturer acting more like a contract assembler. The Pixel is more expensive, too: it starts at 32GB and costs exactly what an iPhone 7 costs.

Google also put more resources behind it, spending 3.2 million dollars on ads in the two days after launch. The Nexus, by comparison, relied mostly on free space in Google's own search engine.

Why do this?

Through Android, Google reaches three times as many smartphones as the iPhone, yet earns a third of Apple's profit.

The two companies are built differently. Apple's revenue comes mainly from the phone itself, while Android users get free software services; each handset brings Google only limited profit, and search advertising remains the pillar it lives on.

The point of the Pixel is that Google can make money from hardware directly, opening a new revenue stream, and can hold a group of mobile users the way Apple does.

The plan has gone badly.

Google has never published Pixel sales, but you can infer them from downloads of Pixel Launcher in the Google Play store. The app runs only on a Pixel, so each download can be counted as one activated phone.

According to tracking by Ars Technica, the app's download count only moved into the "1 million to 5 million" band in June — meaning installations reached 1 million eight months after the Pixel went on sale.

A million units in eight months is not a good pace. For comparison, the first iPhone sold a million in five days in 2007; by the iPhone 6, first-day sales topped 4 million.

The number doesn't look good next to Android phones either. Leave aside the cheap Chinese Android handsets: Samsung's Galaxy S8, released after the Note 7 debacle and priced well above the Pixel, took a little over 40 days to reach a million.

For a company that has always done software and services, every part of the hardware business — supply chains, carrier deals, marketing, sales channels, the next round of hardware development — has to be learned from scratch. Selling phones will stay hard for Google.

Cloud computing is another new business Google has its eye on; the earnings report files it under "other revenue," which grew from 2.172 billion dollars a year ago to 3.09 billion dollars now.

The gap with its rivals is still wide. The research firm Canalys put Amazon's share of the cloud infrastructure market at 31% in the first quarter of 2017, with Microsoft second at 12.3% and Google at only 5.8%.

The virtual reality story is running out too

6

models

The number of phones that support Daydream VR today.

Google's VR project has met a fate much like its phone.

At the 2016 I/O developer conference Google introduced Daydream, a new virtual reality platform made up of reference designs for a headset and controller, a phone certification program, and a software and content platform.

Ideally Daydream would become an "ecosystem" like Android: hardware makers design and build the headsets while Google gathers developers and supplies the operating system.

A year on, Daydream is moving slowly.

SuperData Research reports that Samsung's Gear VR sold 782,000 units in the first three months of this year; Daydream headsets sold less than a quarter of that.

To use one, you have to slot a Daydream-certified phone into the headset.

That bar is high. Six months after Daydream's release only two phones supported it, and one of them was Google's own Pixel.

A year in, the "Daydream Ready" program still covers only 6 phones from 6 brands: the Google Pixel, the Samsung Galaxy S8 line, the Asus ZenFone AR, the Moto Z, the Huawei Mate 9 Pro line and the Axon 7.

Apart from the Samsung and Huawei models, almost none of them sell in any volume.

Developers are not interested either. From the platform's official opening in January through May, Daydream had only 150 apps.

By this year's Google I/O, Daydream had disappeared from the keynote. According to a talk in China by Jon Wiley, Daydream's director of immersive design, Daydream is shifting toward "mixed reality," and Project Tango, the augmented reality team, has been folded into Google's VR division.

This isn't only Google's problem. The whole VR industry has stalled. Oculus, one of the first VR companies and the one Facebook bought, went through a strategy overhaul, and its founder eventually left.

The bets on the future haven't paid off — two years may simply be too short

"Alphabet is about the ability to generate excess returns (Alpha is investment return above a benchmark); that is what we are striving for," Page wrote in the restructuring letter, adding that Alphabet could "accomplish many more ambitious things."

Alphabet has changed over two years, slowly. It has more non-advertising revenue, and advertising itself has found room to keep growing as it moves to mobile.

But the future projects have not reshaped the company in two years. Whether it is called Google or Alphabet, this is still an advertising company.

That has to do with Google's DNA. Taking an existing technology and commercializing it is the blood that has run through the company from the start. Search is the example: it began as a university research project, and advertising was something Google only worked out years after search was born.

Which creates a second problem: to this day Google has never made money from any product in any form other than search advertising.

The Alphabet reorganization shows Google changing, trying to let these frontier projects run on their own and get a little closer to commercialization.

Whether one of them turns into a business that lasts another 20 years — that answer hasn't arrived.

Graphics: Feng Xiuxia

Cover image from Pixabay