For years, Alphabet (GOOG +1.99%) (GOOGL +1.71%) has had a dominant position across much of the internet.
Google Search has a monopoly in most of the developed world. YouTube is a the leading video-sharing platform. Its free web tools like Gmail, the Chrome web browser, and Google Maps also have a majority of market share and strengthen its online ecosystem, and its Android mobile operating system makes up one half of a duopoly in mobile software with Apple's (AAPL +2.65%) iOS.
With all those strengths, it seems like Alphabet has a significant economic moat, and that question is more pertinent than ever with the emergence of ChatGPT and chat-driven search, which prompted Alphabet to call a "code red" and rush its competing Bard AI, which was poorly received in its initial presentation.
That threat and Alphabet's response make it seem as if its moat is suddenly vulnerable, but there's another reason to believe that Alphabet's moat isn't as strong as it might appear.
Image source: Getty Images.
Google's protection payments
If you use Apple devices, you're probably aware that Google is the default search engine on Apple's Safari browser. When you search on an iPhone, Mac, or iPad, you'll automatically be using Google unless you go out of your way to choose an alternative like Microsoft's Bing, Yahoo, or DuckDuckGo.
Apple doesn't do that because it believes that Google is the best search engine. It does it because Google pays handsomely for the privilege.
In 2022, Alphabet was estimated to pay Apple as much as $20 billion to be the search engine of choice on Safari. The payment is not publicly disclosed, but it has ramped up significantly over the last decade as court filings in 2014 showed that Alphabet paid Apple just $1 billion.
Alphabet CEO Sundar Pichai has defended the payments, calling the arrangement a "standard" deal, where his company competes with others in response to allegations that it's anti-competitive.
Whose moat is this?
The nature of Alphabet's protection payments to Apple calls into question its claims to a moat. After all, if Google Search had its own innate competitive advantages, why would it need to pay Apple as much as $20 billion for preferential treatment in its search bar?
For Alphabet, which brought in $162 billion in revenue from Google Search last year, $20 billion may be a manageable fee, but it makes it seem like Apple is really the one with the economic moat here. After all, Apple does virtually nothing to earn that $20 billion, which is essentially straight profit. It's a function of its enviable position in computing hardware.
For Alphabet, on the other hand, the payments may make financial sense, but they also seem to signal that its moat isn't as strong as some might think. By paying Apple so much money, it seems that the company doesn't trust internet users to use Google when given a choice.
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Key Data Points
Why it matters
With the release of ChatGPT setting off a race to develop the next iteration of search, Alphabet looks more vulnerable than it has in a long time, and its search engine doesn't have the typical hallmarks of an economic moat outside its brand and monopoly like market share. From the perspective of the user, Google Search doesn't have any switching costs or network effects. Users are free to go elsewhere. They use Google Search now because they think it's the best option. But if that changes, they're likely to switch.
A more competitive search race could also up the ante to be Apple's preferred search partner. If Alphabet feels threatened, it could be forced to pay Apple even more money for the prized digital real estate, or it could get dragged into a bidding war with Microsoft, which could see an opportunity to turn the tables in search by partnering with Apple.
Whether chatbots disrupt search as we know it is still uncertain. A New York Times reporter just described an encounter with the new chat-driven Bing as deeply unsettling and said it wasn't ready for human contact.
But these generative AI large-language models, which have only just been released to the public, will only get better, and the vision for a better form of search is out there. In that context, it's worth revisiting Alphabet's $20 billion fee to Apple as it's a reminder that Google has less control of its market leadership than it seems.
Investors shouldn't ignore that risk as the next battle in search is just starting to play out.
