The Business Of
Eyeballs | Alphabet | How Do They Make Money?
Morning All!
So yesterday, we started our new series on The Business Of Eyeballs and we set the scene for the week. We explored the history of advertising and saw how Alphabet’s products (Google Search, Google Network, and YouTube) fit into the wider advertising market. Today, we’re going deeper and asking the question - how does Alphabet actually make money from their various segments?
And to help us answer that question, let’s first take a look at where Alphabet’s revenue comes from…
As we can see, Alphabet’s revenue is split between 5 main segments: (i) Google Search, (ii) YouTube, (iii) Google Network, (iv) Google subscriptions + other, and (v) Google Cloud. However, 3 of these segments - Google Search, YouTube, and Google Network - make pretty much all of their revenue from advertising! Which means ~80% of Alphabet’s total revenue comes from advertising!
So today, we’re going to focus on these 3 advertising segments. But don’t worry, we’ll look at Google Cloud and the entire cloud industry when we explore The Business Of Cloud later in 2024! Without further ado, let’s crack on!
No-One Google Searches ‘Motorcycle Injury Lawyer’ For Fun!
Okay so, let’s start with Google Search. How do advertisers (like Huel, Nike, Apple, basically every company on Earth) use Google Search? Well, advertisers know a ton of people are on Google everyday searching for things. And so, they’ll have sponsored links on relevant search pages, looking to reach potential customers! And how does Alphabet get paid in all of this? Well, it’s all about clicks! Alphabet get paid when people click the sponsored links on their Google Search pages.
As an example - in the image below, you can see what comes up when I searched ‘protein works’ on Google. Protein Works is a leading protein shake company in the UK, and so unsurprisingly, there’s a few sponsored links for the company itself. But you also see a sponsored link for Huel! Now, why is this? Well, Huel know that the kind of people who are searching for ‘protein works’ are probably going to also be interested in Huel. And so the company want to advertise to them! And every time somebody clicks on that sponsored link - Google make money!
Now, question - how much do Google/Alphabet get paid when one person clicks on that Huel link? Well, great question! Because there’s a lot of variation here. In general, the average cost per click (CPC) for advertisers is ~$1-3. And so Huel will probably be paying Google ~$1-3 every time someone clicks on that link. However, this can vary greatly depending on what’s searched!
For instance, when people search ‘motorcycle injury lawyer’ on Google. And they click on a sponsored link from a law firm. Guess how much money that law firm has to pay Google? Over >$200! For just one click! And the reason for that is because of intent. These law firms know that if someone has searched ‘motorcycle injury lawyer’ in Google, they’re not just searching that to browse lawyers! There’s a high chance that person has had an accident. And is desperately in need of a lawyer. So law firms all compete to get a slot at the top of this search page. And they don’t mind paying >$200 for a click… because they know if that ‘clicker’ becomes a customer, they could make thousands of dollars from them!
Okay, so we know how much Google get paid on average per click. But question - how many people actually click these ads? Well, according to this article, only ~2% of people who search something on Google click on a sponsored link!
So, let’s say 100 people searched Google for ‘protein works’ as we saw earlier. On average, only 2 of them will click the sponsored links (from Huel and Protein Works). So, how much will Google get paid? Well, we saw earlier that Google will make ~$2 per click. Which means they’ll make ~$4 in total! Which doesn’t seem a lot…
Well, yes you’re right, ~$4 really isn’t a lot! But in our example, we said 100 people used Google Search. Now, the reality is just slightly different. Because guess how many searches were actually carried out on Google last year? A mind-boggling ~4 TRILLION SEARCHES! You can find a list of the most popular Google Searches of 2023 here. No surprises, Barbie and Oppenheimer are well up there?!
But anyway, back to Google Search’s revenue. What’s ~4 trillion x ~2% x ~$2.2? A mammoth $175 billion! And below, we can see a description of the drivers to make things nice and clear!
Now, I want to quickly mention something here - and that’s reach. Yesterday we said that advertisers have preferred digital channels vs traditional channels because digital platforms like Google are great at targeting relevant audiences.
But the other main reason advertisers love channels like Google Search and Facebook is because of the ridiculously huge reach. In 2023, ~4.9 billion people used Google Search!And so advertisers who advertise on Google, are reaching a ridiculously high % of the global population! Much more than if they advertised on any other platform in the world! And this value for advertisers results in advertisers spending more and more of their marketing budgets with Google Search!
More Sponsored Links Being Shown, More Sponsored Links Being Clicked!
Okay, so let’s stay with Google Search for just a bit longer. We know Google Search makes an awful lot of money. But how have these drivers progressed over the years? Well, the chart below gives us an indication. The number of paid clicks on Google Search has grown an incredible ~30% CAGR since 2012. Which means there were ~17x more paid clicks in 2023 than they were in 2012!
And the reason for this is two-fold. One, more people are using Google Search every year. And two, the % of people clicking sponsored links is growing! Now, I want to focus on this second part - why is a higher proportion of people who search on Google, clicking on sponsored ads?
Well, the answer is because of the NUMBER of ads Google are putting on their first pages! The image below shows us a comparison for the search ‘drake hotel, chicago’ - a hotel in Chicago! The image on the left shows us what appeared back in 2001 when someone searched that. And the image on the right is from 2024. As we can see - in 2001, there were just 2 sponsored links that searchers could see. However, in 2024, a searcher would see 8 sponsored links! Now again, this varies based on the search phase, location, etc. But the point is the same. More sponsored links has meant a greater chance that people click on these sponsored links!
Okay, so that’s what’s been happening with the number of paid clicks over the years. Now, let’s look at the third driver of revenues - revenue per click. And it’s interesting to note that Google haven’t actually got loads of control over this. Which is strange because on TBO we’ve banged on about how important pricing power is for a company.
And the reason Google don’t have loads of control over this is because the cost that advertisers pay per click is set by an auction! Let’s go back to Huel again. How much will they have to pay Google when someone searches ‘protein works’ and clicks their sponsored link? Well, it’s based on how much competition there is from OTHER ADVERTISERS for that search term. As we saw earlier, law firms all want top spot for ‘motorcycle injury lawyers’ and hence they bid high amounts in the auction. Which means Google makes a lot per click. Now, we won’t go into detail about the auction process here - but I highly recommend checking out this simple article!
Google Display Network Is Twice As Big As Blackrock!
Okay, so that’s Google Search. But search advertising isn’t the only way Alphabet makes money from Google. There’s also display advertising. And it’s time to talk about Google’s Display Network! Below is the graphic we saw yesterday which shows how the network works.
As we saw yesterday, Google’s Display Network is made up of many websites (>100m) that want to sell the ‘space’ on their web pages to generate ad revenue. And these websites want Google to act as a middleman and send them advertisers.
Now, we don’t know for certain which websites are a part of this network. But in the screenshot below, we can see a potential example. On this Daily Mail web page, we see a display ad slot being taken up by Singapore Airlines. And Google may well have been responsible for connecting these two parties!
So okay, let’s say Daily Mail is a part of Google’s Display Network. And Google did send the Singapore Airlines ad to them. How do Daily Mail and Google make money from this display ad?! Well, the answer is clicks and impressions! Now clicks is what we’ve already seen. Someone clicks on the ad. Singapore Airlines pay Daily Mail. And Google will take a cut of this!
No issues there! But what are impressions? Well, an impression occurs when someone just SEES an ad. So, when someone goes onto that Daily Mail web page and just SEES that Singapore Airlines display ad… an impression is created. And for every 1,000 impressions, Singapore Airlines will pay Daily Mail a certain amount. And again, guess who takes a small cut? That’s right - Google! The image below shows us another example of this. The Investopedia web page has a display ad at the top (for a trading app called OANDA). And a display ad on the right (for something called ALPHA).
Now, here’s a couple of questions - why do some advertisers prefer paying for clicks vs impressions? And why do others prefer impressions to clicks? Well, great questions. But this is a whole other topic and we don’t have time today! However, this article give a wonderful explanation of how clicks, impressions and Google’s Display Network all work together!
But the important thing for us to remember now, is that Alphabet don’t just make money when people search on their own site (e.g. Google) and click on ads. They also make money when people browse millions of other websites and just SEE ads! And not just a bit of money… they make a whopping ~$32bn of revenue from their Google Display Network!
Now, that ~$32bn is quite a bit below Google Search’s revenue ($175bn). But ~$32bn is still nearly 2x as much revenue as Blackrock made last year! Think about that. The revenue Google makes from ads on websites not run by them, is nearly 2x greater than the revenue of the biggest asset manager in the world! Crazy!
If 10,000 People See A YouTube Ad, Only 6 Of Them Will Click On The Ad!
Okay, final part for today is YouTube - the 2nd most popular website in the world! And we’ll be fairly brief here because we’ve already seen a lot of the main concepts (clicks, impressions) earlier today.
So, very simply - companies (like Nike Huel, etc) who want to reach potential customers in YouTube’s audience, choose to advertise on the website. And YouTube get paid whenever one of us clicks on an ad. Or when one of us just sees a company’s ad! In the image below, we can see Shopify advertising on one of MrBeast’s latest videos. And we’ll be talking about MrBeast in some detail tomorrow!
Now, one thing I want to mention here is the click-through rate (CTR) for YouTube vs Google Search. Earlier, we saw that, on average, ~2% of Google Search users end up clicking a sponsored link. But what % of YouTube users do we think click on these YouTube ads? Well, the answer is - a lot less! Only 0.65% of people who see a YouTube ad click on it! And I guess this makes sense - YouTube ads are seen as much more of a nuisance vs the sponsored links on Google Search.
However, as we can see from the chart below, this low CTR hasn’t seemed to affect YouTube’s topline too much! From 2017 to 2021, revenues grew rapidly from $8bn to $29bn as the pandemic saw a surge in people using YouTube more than ever!
And by the way, the recent slowdown isn’t something YouTube has faced alone. It’s something other digital advertising players like Meta, Snap, and Microsoft have also faced as advertisers have reduced their marketing budgets.
However, the rising competition from TikTok may be something to watch out for in coming years. More specifically, will YouTube’s focus on ‘Shorts’ eat into their higher-revenue generating ‘Long-Form’ videos? We’ll find out in a few years!
From $3bn (2004) To $307bn (2023). What An Astonishing Company…
Alrighty, let’s wrap up! We’ve looked at how Alphabet makes their money from Google Search, Google Display Network, and YouTube - their 3 advertising segments. And a couple of decades ago, Alphabet really didn’t do much else!
However, as we can see from the chart below, non-advertising revenues have gradually become a larger proportion of the pie. With Google Cloud, Android phone sales, and a host of other ventures now worth ~23% of revenues!
As we said, we’ll dive into Google Cloud a bit later on in the year when we look at The Business Of Cloud! But for now, let’s end on one final, beautiful chart below. And that is a chart of Alphabet’s total revenue growth from 2004-2023.
And what a sight that is. Alphabet’s revenues have grown at a quite breathtaking ~27% CAGR for 20 years! From $3bn in 2004 to $307bn in 2023! And arguably even more remarkably, REVENUE GROWTH HAS NEVER ONCE BEEN NEGATIVE! Not even in a single year! What a company.
27th Feb 2024
And that’s a wrap! I hope you enjoyed breaking down how Alphabet makes its money. Tomorrow, we’ll crack on with looking at the company’s margins. And let’s see if they’re as remarkable as Alphabet’s topline!
Have a fabulous day!
The Business Of Team