Alphabet Inc, the corporate parent of Google, saw its shares suffer steep losses on Tuesday despite announcing forecast-topping profit and revenue for the first quarter.
The reason for the selloff: a sharp rise in costs and spending and a big contraction in gross margins.
Noting a spending binge by the tech giant on hardware and cloud platform, investors wondered whether the expenditure will yield the desired results or dent the firm’s profitability going forward.
According to an announcement after US market close on Monday, Alphabet’s capital expenditure reached US$7.7 billion in the first three months of this year, up from US$2.5 billion a year earlier.
Costs rose as the company scaled up investment in facilities, production equipment and data center construction, in what seemed to be a risky gambit to maintain a competitive edge in the market.
Operating margin, meanwhile, slid to 22 percent from 27 percent in the same period last year.
Google has been the market leader in online advertising for many years. But the dominance has come under a threat due to Facebook, as the latter made huge strides in monetizing its user traffic by introducing more advertisement formats on the social network platform.
In addition, Google is also facing a stiff challenge in boosting its hardware business as it confronts competitors such as Apple and Amazon.
Following a US$1.1 billion acquisition deal for the ODM team of Taiwanese smartphone maker HTC, Google is scrambling to strengthen its own brand handset business.
Media reports have suggested earlier that Google is stepping up efforts to make its own flagship device products with self-developed processor. The move was apparently aimed at challenging Apple’s dominance in the high-end smartphone market.
Google’s CEO Sundar Pichai, however, told investors on Monday that the group’s hardware unit is two to three years from “the scale that we want to see”.
The investment required for this includes custom chips designed in-house, an expensive skill that Apple has been developing for years, as Bloomberg News noted.
Google has its own brand Pixel smartphone and tablet products running on Qualcomm processor. But Pixel 2 smartphone was the first product to embed with a Google self-developed chip for its camera, which was the first Google chip for the mobile platform.
Meanwhile, the Google Home smart speaker is competing with Amazon’s Echo speaker. As of now, Amazon has more than 75 percent market share in the US smart-speaker market and Google has been a relative underperformer in that key segment.
Of course, Google’s management is looking at more than just the hardware business.
CEO Pichai said the company will boost data center growth and scale up network capacity through undersea cables, and also enhance the group’s capabilities in machine learning technology, the Google Assistant artificial intelligence application and cloud computing.
Machine learning appears to be a key focus of Pichai, going by his comments during a post-results conference call.
According to the CEO, machine-learning-powered products like Google Photos, Google Lens and Google Assistant are serving users in their daily lives. The company is said to have added, in just the last four months, over 200 new device partners that work with Google Assistant, as it sought to enhance the service penetration.
In addition, Google launched Cloud AutoML solutions that allow enterprise users to deploy complex neural nets and security products based on machine learning technology. Such offering helps Google boost its competitiveness in the cloud segment, where Amazon Web Services is the market leader.
All this is fine, but the fact remains that Alphabet needs to do a lot more than just boost spending if it wants to achieve a diversified business portfolio and secure a more balanced revenue mix.
While it positions itself as an Internet entity, the reality is that it is more of an advertising platform. In the first quarter, the group derived nearly 90 percent of its revenue from selling advertising on the internet.
But now, following the Facebook data misuse scandal, Google faces increased scrutiny as well as the prospect of more regulation on key aspects of its business.
The company’s existing business model of collecting user data to provide targeted marketing solutions could become a major problem in the future.
Given this, Alphabet can’t afford to be complacent in seeking adjustments in its revenue sources as well as business strategy.
The surge in expenses is clear sign that Alphabet is still searching for the next growth engine after its search business.
Only time will tell if the group will succeed fully in its mission.
Investors, meanwhile, need to be patient and not rush to any hasty conclusions.
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