In early 2017, Capital Flywheels discussed how Google’s business model was at risk of AI disruption.
Back then (and even until very recently), most people assumed Google to be the leader in AI. If anything, the mainstream narrative seemed to be the other way around: Google, armed with an insurmountable edge in AI and data, was on the verge of disrupting tech and beyond, including healthcare, autos, and more.
However, the narrative around Google has shifted significantly over the last few months.
With the launch of ChatGPT, its integration into Bing, and the recent rumors of Samsung potentially looking to drop Google Search in favor of Bing, Google certainly appears increasingly vulnerable.
Given these circumstances, it seems timely to revisit the argument and see what’s changed.
To start, it’s important to draw a clear distinction between Google the tech organization and Google the business organization.
Both back in 2017 and now, I do not think Google is behind when it comes to the technology involved. Google very likely remains in the lead or at least as capable as its most capable peers today. In fact, most of the core technologies that have fueled this recent wave of AI developments came from Google R&D, including the development of transformers.
But what hasn’t changed is Google’s business model. And it is this business model that is at risk and increasingly so.
Back in 2017, Capital Flywheels noted that Google Search and the advertising business model, in general, runs counter to the developments in AI. If AI works, the value of search and advertising business models are potentially at risk:
So now turning to the business model – Google Search makes money on the ads that appear alongside search results. Every click on an ad (as opposed to an organic result) generates a small bit of revenue for Google.
In essence, the existence of ads on Google Search is the most egregious effigy to the failure of the underlying search algorithm. Every time a user clicks on an ad, it is an implicit acknowledgement that Google Search did not accomplish its job-to-be-done, that the desired answer would not have been provided had the advertiser not paid for that placement.
Given a long enough time horizon, if Google Search is truly improving, barreling towards a future where Google can answer any question without doubt and with perfect context, Google’s business model would have to evolve because ads do not have an obvious place in that future.
And that future is coming closer with the advancements in AI.Source: What Apple, Google, and Facebook’s Business Models Tell Us About Their Ability to Adapt to the Coming AI-Future
Unfortunately for Google, I believe all of that remains true today.
While Google is probably not behind when it comes to AI technology, Google increasingly needs to make some painful business choices if it wants to compete in AI.
Microsoft / Bing can afford to integrate ChatGPT…the risk of losing revenues is low given Bing’s small size but with potentially immense upside.
The same is not true for Google…
Back then, I charitably assumed that Google continued to invest in hardware as a way to de-risk its AI future:
It also makes Google’s persistent pursuit of a hardware/software business model a la Apple much more understandable. Perhaps selling hardware isn’t just about protecting access to market (after all, it’s unlikely that Android will be unseated now that it is so entrenched, so why continue with the direct hardware efforts?), it could be a deliberate attempt to evolve their business model to ensure financial relevancy in the AI-driven future.Source: What Apple, Google, and Facebook’s Business Models Tell Us About Their Ability to Adapt to the Coming AI-Future
Sadly, I think I was too charitable. Despite the continued dominance of Android around the world, Google has failed to build an independent business model out of it other than to further shore up the dominance of Google Search.
As it was and as it is now, Google continues to place essentially all its chips on Search (and advertising). Everything else is just another road to Rome.
Disruption will take time, though. Despite the significant interest in ChatGPT and generative AI, it will take years (maybe even decades) to change consumer habits. Search is something everyone is already familiar with, and it mostly works. ChatGPT does not appear to be an unequivocal improvement for most search queries at the moment, further limiting the near-term impact for disruption.
BUT, while the business may still be safe for a while, the stock may be a different story.
Investors are forward-looking. And for a stock with a 20+ P/E multiple, investors are implicitly assuming that the business will retain its earnings power for at least a decade or more. If rapid developments in AI continue to negatively impact investors’ confidence in Google’s earnings power 10+ years out, the multiple may erode even if Google is able to continue to deliver good near-term results.
The last few years have shown us how fast AI can move when breakthroughs happen.
And a lot can happen in the next 10 years.
In parallel with my concerns around Google’s business model, I also argued in 2017 that Apple was far better positioned for AI than people were willing to give it credit for:
Apple’s business model, on the other hand, is much more aligned. Sell the best products available for customers’ job-to-be-done.
AI is not orthogonal to this pursuit and business model. The only question is whether Apple has the technological capabilities to do so. However, even under the assumption that Apple is not the leader in AI-technology, it is not clear that it matters. After all, Apple was not the original leader in GUIs (Xerox PARC was). Apple was not the original leader in phones (Microsoft, Palm, Blackberry, Nokia, etc. were). Despite not being the original leader, Apple had the business model and insight to ensure that they could ride the underlying technological trend, and if I were to take a bet today, I believe Apple’s business model makes them more prepared to usher in an AI-world than Google is. AI is a feature to Apple. AI is a potential danger to Google’s business model.
From a business model standpoint, Apple is far more robust in an AI-world.Source: What Apple, Google, and Facebook’s Business Models Tell Us About Their Ability to Adapt to the Coming AI-Future
While Apple’s dominance is relatively unquestioned today, back then Apple was still trying to get away from significant concerns around its long-term future, especially its lack of AI capabilities. Back then, the dominant narrative was that Apple was destined to lose the AI race because of its unwavering stance on privacy, depriving it of access to data necessary for AI.
Although we have yet to really see Apple’s AI strategy take shape, Microsoft’s (I wish I had paid more attention to what Microsoft was doing. The turnaround at Microsoft over the last 10 years has been a major blindspot for Capital Flywheels, but what Microsoft has accomplished is truly worthy of praise.) sudden burst onto the scene certainly makes a point: Distribution and business model are important considerations, perhaps even more important than technology. Microsoft’s distribution scale and aligned business model allowed it to leap ahead even though it does not control the core technology and is leveraging OpenAI’s capabilities.
And if there’s any other company that has the sort of distribution scale and aligned business model to quickly close the gap, it would probably be Apple.
Lastly, I closed off the discussion in 2017 with a few comments on Facebook. Despite Facebook’s advertising business model, Capital Flywheels argued that it did not face the same sort of pressures that Search did / does:
Facebook’s an ad-driven business model. What about them? Surely, Facebook is potentially in danger as well.
Facebook’s situation is less clear cut because the job-to-be-done for users is different vs search. Search has a “right” set of answers. Facebook’s feeds do not. Users are not necessarily searching for anything specific but rather using the services as an outlet for time. The “wrong” answer in a search query is far more obvious than a “wrong” answer in a Facebook feed.
And if AI can be used effectively to ensure that organic content on News Feed, Instagram, etc. are more relevant and engaging, then perhaps that can even offset any deterioration in experience from an increase in ad load. AI can never make Google’s organic results more engaging to the point where a user will tolerate a less user-friendly ad environment.
Facebook’s job-to-be-done is to, cynically, offer a time sink. Google’s job-to-be-done is to get you your answer as fast as possible. One of these is more complementary for an ad-driven business model.Source: What Apple, Google, and Facebook’s Business Models Tell Us About Their Ability to Adapt to the Coming AI-Future
What I wish I wrote about was a little company (little back then…) called Bytedance. While I was following its development closely when It was still known only for its Chinese news app called Toutiao, it has since taken over the world through a very different app called TikTok (which launched in China only 6 months before the post) effectively executing on the AI-driven thesis Capital Flywheels outlined for Facebook.
Jumping forward a few years to 2023, a lot has stayed the same but a lot has also changed.
Not much has changed about Google’s business or business model, but increasingly the risks are becoming more visible to the mainstream.
Not much has changed about Apple’s business or business model, but Microsoft has revealed the power of distribution when it comes to AI.
Not much has changed about Facebook’s business or business model, but Facebook has clearly been blindsided by the rise of AI-centric TikTok and out-executed on nearly every front.
What is obvious is that business models are hard to change and rarely change. So in a rapidly developing world where AI is potentially on the cusp of driving deep transformation on the level of perhaps the industrial revolution, focusing on companies with the right business models remain more important than ever.