Alphabet (GOOG +1.44%) (GOOGL +1.71%) continues to build upon its formidable lead in digital marketing. According to eMarketer, Alphabet/Google is estimated to take nearly 43% of all U.S. digital advertising, a figure thought to be $40 billion after traffic acquisition costs.
While Google's digital marketing empire is enough to support its stock price, the company has been aggressive in its efforts to develop additional revenue sources. A natural fit for Google is to expand its presence in high-growth cloud computing organically or via acquisition.
According to Diane Greene, CEO of Google Cloud, the company is taking an all-of-the-above approach, working to compete versus the cloud giants in its current form while looking to make a major acquisition -- if it makes sense and is reasonably priced.
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The cloud leader changes based on definition
Google finds itself behind cloud leaders Amazon.com (AMZN +3.47%) and Microsoft (MSFT +2.11%). Although Amazon is often considered the clear leader, surprisingly, Microsoft has a larger run rate (revenue attributable to the cloud), at $21.2 billion versus $20.4 billion from Amazon Web Services (AWS).
The discrepancy is due to the semantics of what constitutes cloud revenue. When most people think of traditional cloud computing, they refer to the base layer of the cloud stack, infrastructure-as-a-service, or IaaS. That is where Amazon continues to lead with AWS. However, when you include revenue attributable to the full cloud stack, especially software-as-a-service, or SaaS, then Microsoft takes the lead.
While SaaS is typically the cloud stack most directly interacted with, it is often not considered true cloud revenue by many industry purists. The choice of whether to include SaaS in cloud revenue often depends on what narrative you choose to believe. Those who tend to not consider SaaS as true cloud revenue support Amazon. Those who include SaaS support Microsoft, due to Office 365 subscription revenue comprising a large percentage of its cloud-based revenue.
Unfortunately, Microsoft doesn't report separate numbers for its Azure product, which is often considered an apples-to-apples comparison to AWS in the IaaS part of the cloud stack. Analysts estimate Azure revenue has a run rate of $5.4 billion. As a comparison, Greene recently noted Google Cloud has a $1 billion per quarter run rate ($4 billion), but like Microsoft it reports full-stack revenue including SaaS.
Where Google wants to move
It's likely that Google is looking for two key prerequisites in a potential acquisition target. The first is a company that would complement Google Cloud's perceived weak areas in the stack. As previously mentioned, Microsoft has the cloud lead, in part, due to its fully integrated stack offering.
The second, perhaps more important, prerequisite is that the acquisition would help Google better compete versus Amazon and Microsoft in the enterprise. Greene raised eyebrows when she noted investment bankers have pitched floating deals for Google to acquire enterprise-software firms like Red Hat and ServiceNow, which would check both boxes by helping the company offer more-comprehensive full-stack enterprise solutions.
However, even if Google doesn't announce a splashy cloud acquisition, the company could still be working to build its cloud-based revenue. Recently, Google and Cisco announced a hybrid-cloud partnership with a focus on enterprise applications and security. In the short run, it's unlikely Google Cloud will surpass AWS and its IaaS leadership due to lock-in effects, or Microsoft and its full-stack solution, but the cloud market is not winner take all.
Look for Google to grow revenue attributable to the cloud, which will show up in the "Google other revenues" section of its financial reports.
