It’s only been days since Microsoft (MSFT -1.40%) announced its ChatGPT-powered version of Bing, but Alphabet (GOOG 0.66%) (GOOGL 0.82%) stock is already feeling the heat. 

Shares of the Google parent fell 12% over a two-day span last week after Microsoft unveiled the new version of Bing and as Alphabet’s competitor, Bard AI, disappointed in its presentation due to a factual error.

Ever since the launch of OpenAI’s ChatGPT last November, Alphabet has been rushing to come up with a response to protect its search empire. The company declared a “code red” over the threat, and co-founder Sergey Brin, who hasn’t had a day-to-day position with the company in years, returned to the company to help develop a strategy.

It’s clear why Alphabet is in a panic over ChatGPT, a generative AI technology that can code, write poetry, and tell jokes. ChatGPT appears to represent the next step in the evolution of internet search as the technology can answer follow-up questions, neatly summarize complex information, and synthesize research from multiple sources.

But there’s another reason why Alphabet feels so threatened by the new technology. Search represents the lion’s share of its business. 

A chart showing Alphabet's revenue streams

Image source: Motley Fool.

As you can see from the chat above, Google Search brought in 56% of the tech giant’s revenue in the fourth quarter. Alphabet doesn’t break out profits by business segment, but search almost certainly brings in an even greater percentage of its profits. Google Cloud still loses money and Google Other is made up partly of devices like the Chromebook, Chromecast, Google Home, and Pixel phone that it sells near cost in order to drive the use of its services. Additionally, Google Network is closely connected to Google Search, as many search ads run on affiliate websites on Google Network.

If Alphabet loses its search dominance, much of the remaining business may fade with it. If the company starts to cede market share, it will have to spend money to defend itself, investing more in AI, marketing, or other features. That will eat into profits and its ability to fund other businesses like Google Cloud and other bets like its Waymo autonomous vehicle project, which continue to lose billions of dollars annually.

A new era

Alphabet has been trying for years to diversify its profit streams away from advertising and search, but it’s been largely unsuccessful. In 2015, it rebranded from Google to Alphabet, signaling that the company aimed to be more than just the Google family of products. Investors cheered the move, but new businesses like Waymo have disappointed. The self-driving car subsidiary was valued at $175 billion at one point, but it’s now estimated to be worth only a fraction of that as deploying autonomous vehicles on the road has been harder than anticipated.

Similarly, Google Cloud has also been a disappointment as its cloud infrastructure business loses billions of dollars a year, while competitors like Microsoft Azure and Amazon’s AWS have become huge profit centers.

Microsoft also understands that search is both Alphabet’s strength and its Achilles’ heel.

In a recent interview with Financial Times, Microsoft CEO Satya Nadella said, “From now on, the [gross margin] of search is going to drop forever,” implying that Alphabet will need to spend more on computing power to provide chat-based features or it would lose market share to Microsoft. Then, Nadella explained that it was in Microsoft’s interest to wage this battle, calling it asymmetric and saying that Google has to defend every point of its market share.

With the launch of ChatGPT, Alphabet will need to out-innovate Microsoft, or it will risk losing its search dominance. As the chart above shows, that’s a risk Alphabet can’t afford.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Jeremy Bowman has positions in Amazon.com. The Motley Fool has positions in and recommends Alphabet, Amazon.com, and Microsoft. The Motley Fool has a disclosure policy.



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