A prophetic view from Google's and Alphabet's offices in Amsterdam, the Netherlands. Image source: Google.
To many people, Google is nothing more than a simple search service. Enter a query, peruse a list of results, then move on to whatever is was you really wanted to see. Google just makes it happen, then gets out of the way.
For others, Google and its parent company Alphabet (GOOG 0.15%) (GOOGL 0.57%) are a much larger presence in the modern world. From Android phones to self-driving cars, these names are everywhere -- but who has time to figure out exactly how it all fits together?
Let's take a peek behind the curtain. First, I'll tell you more about how Google's core services actually work. Then, let's take an investor's overview of the larger Alphabet conglomerate and describe how this company actually makes money.
Google's innards
It's true that Google was built around its eponymous search engine. In the mid-1990s, when the Internet was young and search engine results often unhelpful, company co-founders Sergei Brin and Larry Page came up with a new way to rank results. They built a prototype in a garage, hosted it on a computer made out of Legos, and the rest is history.
The very core of Google's service hasn't changed all that much in 17 years. A set of servers sends out so-called "crawlers" to collect live data from the Web. These crawler programs come back with fully loaded pages, following links as deep as the target sites will allow, and dump all that information into a massive database. Web masters can also send information more directly to Google and other search engines, in order to stay as current as possible.
Then, you go searching for "anagram" or "zerg rush." A different set of Google-owned computers dips into the database we noticed earlier, pulling out millions of results from billions of data points. These are filtered, sorted, and served up to you by a sophisticated set of algorithms, which happen to be some of Google's dearest and most proprietary business secrets. Landing near the top of the results for very popular search queries such as "Kim Kardashian" or "what is Bitcoin" -- or failing to do so, when you had expected to make it to the top -- can make or break entire business models.
From the user's point of view, Google's job is done at this point. The result has been found and delivered, followed by a quick click. Thanks, see you later!
Making money
But maybe you already made Google some money here. The results often include several paid advertisements, right at the top of the true search results. They have been vetted by programs just as brainy as the search engine itself, only tuned to maximize the dollar value and information content of the final results. Click on those, and Google makes money. These links are often just as useful as the basic search results, given prime real estate on your screen, and don't cost you a penny to use instead of the free link that's found three inches below.
Ad sales account for essentially all of Google's revenue and 89% of Alphabet's total sales. The Google-branded text and banner ads you find on sites not owned by this company only account for 22% of Google's overall advertising revenue. The rest comes from ads tucked into search results, Gmail messages, and other Google-owned content.
This is the lifeblood of Google itself, making it a viable business model with strongly positive revenues and cash flows.
Wrapping the business in an Alphabet
Other revenue includes fees collected from the Android app store, sales of mobile devices under the Nexus brand, and cloud computing services. So far, the non-ad extras remain tightly grouped around the Google brand.
That should change in the next few years, which is why CEO Larry Page recently went to the trouble of wrapping Google in a separate business structure and a whole new name.
In October's third-quarter earnings call, Alphabet CFO Ruth Porat offered some detail on the reasons behind this move:
We remain focused on solving the biggest problems and solving them at scale and that presents sizable potential revenue opportunities. It was a key catalyst for creating Alphabet.But these opportunities also require investment. And so the focus of our team is on prioritizing these opportunities over a multiyear period.
...
What we want with Alphabet is to be an extraordinary magnet, the best magnet for entrepreneurs, and to be an accelerator for their development.
We want to give them that the kind of environment where we can continue to thrive, and therefore build great businesses that generate tremendous returns for our stakeholders as well, on top of solving big problems.
That's Alphabet in a very large nutshell.
You can view the wrapper structure as perhaps the most ambitious upstart development fund ever created, directly powered (for now) by Google's search and advertising muscle.
At the moment, Alphabet is investigating new business ideas such as driverless cars, advanced healthcare services, wearable computing, and renewable energy solutions. But that's just the start. As these ideas mature, some will fail and fall to the wayside while others mature into revenue-generating and profitable value drivers. Today, Alphabet is fairly synonymous with Google. Come back in five or 10 years, and Google may have become a minor operation tucked into a sprawling Alphabet conglomerate.
The company still operates under a tight set of 10 core values. First on the list is this:
"Focus on the user and all else will follow."
Fame, fortune, success, even money -- none of these are goals in and of themselves for Google or Alphabet, but they follow naturally when you treat the user right. Yes, even the money.
