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Alphabet Q3 earnings show AI Mode searches earn less than old search ads
The company is currently forced to rent computing power from outside providers because it has invested $51 billion in its own infrastructure, illustrating a current hurdle for its AI initiatives.
Shares in Alphabet, the parent corporation of Google, dropped by nearly ten percent on Wednesday following the web giant's disclosure that its AI-driven searches generate less income compared to the revenue derived from its established search engine advertising. Alphabet released its third-quarter financial results on Wednesday, which revealed that the rate of growth in its search queries year-over-year represents the highest figure seen in the preceding five years. A portion of this expansion stems from users beginning to utilize "AI Mode," which is Google's newest search system powered by a large language model.
Google's revenue from search climbed by twelve percent compared to the previous year, reaching $63.25 billion, although this figure was slightly below the fourteen and a half percent growth reported in the third quarter of the prior year. During the earnings call, chief business officer Philipp Schindler attributed this deceleration to "lower monetization we were seeing in AI Mode." This presents a significant concern considering the substantial amounts of money Google is dedicating to infrastructure development. In the third quarter, $51.4 billion was expended, with roughly two-thirds of that sum allocated to networking and server hardware, while the remainder financed data center construction.
This heavy spending appears to have affected the company's profitability, as Alphabet posted a net income of $26.17 billion for the quarter. For comparison, the third quarter of last year, when Google generated $102.35 billion in revenue, yielded a net income of $35 billion. Schindler maintained that the AI search functionality will eventually prove beneficial. He informed investors that "On AI Mode, many of these queries are upper funnel queries, allowing us to capture new, high-value commercial intent," and further noted, "In addition, the majority of AI Mode queries are incremental, creating more monetization opportunities over time."
In an effort to capitalize on one of these opportunities, Google began enabling advertisements alongside AI Mode searches globally today, following initial testing restricted to the United States. Nevertheless, at present, AI Mode searches do not generate as much profit as Google's existing search business, which contributed just under half of Alphabet's $125.8 billion in quarterly revenue. Google's cloud division is its second largest income source, bringing in $24.75 billion for the quarter, yet it faces its own difficulties because the massive corporation lacks sufficient capacity to accommodate all its clientele. The firm has started diverting some customer workloads to external vendors and issued a warning that this will negatively affect its margins going forward.
Thomas Kurian, the CEO of Google Cloud, mentioned that more than one hundred enterprises are utilizing its TPU silicon, adding that "All of the inventory for TPU systems are associated with committed contracts," which means Google can anticipate some revenue to offset capital expenditures. The organization anticipates receiving income from TPU sales made to third parties in subsequent quarters. CEO Sundar Pichai expressed considerable optimism regarding forthcoming AI-related earnings, pointing out that Google's Gemini application has attained a billion users faster than any other product in the company's history, while also commending the capabilities of its models. He stated that Google is moving rapidly toward developing agentic AI tools, though initially, the focus will be on business customers, "because the bar for security, safety, and governance is extremely high." He further elaborated, "As a next step, we are bringing these features to Search and also, of course, to our billion users on the Gemini app." Pichai did not specify a timeline for when agentic AI will appear in search, nor did he offer assurances that it will circumvent the monetization challenges already present with AI Mode. Despite this, the company maintained its forecast for capital spending this year, set between $195-$205 billion, and indicated its intention to spend "significantly" more in 2027.
Why it matters
This highlights the immediate financial challenges developers and businesses face when adopting new AI-driven tools. The discrepancy between massive infrastructure spending and current AI search monetization raises questions about the near-term ROI of large-scale LLM implementations. Watch for how Google integrates monetization strategies into its AI features moving forward.
