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Alphabet Inc. Should Fear Windows 10

By Sam Mattera – Nov 30, 2015 at 7:21PM

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The steady rise of Windows 10 should put pressure on the dominance of Google's search engine.

Windows 10 logo. Photo: Microsoft

More than 110 million devices are powered by Microsoft's (MSFT -2.36%) latest operating system, Windows 10 -- and that's a problem for Alphabet (GOOG -3.29%) (GOOGL -2.75%). Windows 10 includes deep integration with Microsoft's search engine, Bing. Although Bing remains in a distant second place behind Alphabet's Google, the launch of Windows 10 is already having a positive affect on Microsoft's search business. As Windows 10 sees greater adoption, that trend should continue.

Bing finally achieves profitability
For most of its history, Bing has been a source of red ink and heavy criticism. In 2011, Bing was burning the Redmond tech giant for around $1 billion per quarter. Some, including hedge fund manager David Einhorn, encouraged Microsoft to sell it. But over the last four years, the situation has changed drastically, and last quarter (for the first time) Bing achieved profitability. According to management, it wasn't a fluke. "We expect Bing's strong trajectory to continue, remaining profitable for the remainder of the [fiscal] year," said CFO Amy Hood on Microsoft's most recent earnings call.

That profitability has been driven by greater usage. Bing's share of the U.S. search market rose to 20.7% last quarter, up from 19.8% in February. According to analytics firm comScore, Bing's share rose another 0.1% last month, hitting 20.8% in October. Alphabet's Google, meanwhile, has seen its share of the U.S. desktop search market fall modestly over the same period of time -- from 64.5% in February to 63.9% in October.

What Microsoft can do to take more share
In its earnings slides, Microsoft identified Windows 10 as being the primary catalyst for Bing's profitability. By default, the Windows 10 browser, Microsoft Edge, directs users to Bing. The same was true of Microsoft's former browser, Internet Explorer, but Edge also includes Microsoft's digital personal assistant, Cortana, which relies on Bing. Moreover, Microsoft explicitly discourages Windows 10 users from downloading rival browsers that may rely on other search engines. 

More importantly, the Windows 10 taskbar includes a search field that's powered by Cortana (and by extension Bing). "[Bing was] helped by Windows 10 users asking Cortana more than 1 billion questions," said Microsoft CEO Satya Nadella on Microsoft's earnings call.

Windows 10 has enjoyed rapid adoption since it launched in late July, but there are still hundreds of millions of additional PCs that could be upgraded to Windows 10 in the months and years ahead. The total number of installed PCs is around 1.5 billion, giving Windows 10 a penetration rate of under 10%.

Microsoft plans to bring Cortana to its Xbox One video game console next year, which should drive additional incremental search queries. It's also in the process of testing Cortana apps for iOS and Android. Using a single Windows account, iPhone and Android handset owners can link Cortana on their mobile phones to Cortana on their Windows PC. That utility could bring greater Cortana usage, and drive more search traffic to Bing.

A new operating system for traditional PCs
Microsoft isn't forcing Windows 10 users to take advantage of Cortana or to use Bing -- they can still turn to Alphabet's Google. Given that Google still controls around two-thirds of the U.S. desktop search market, many likely are. But Windows 10 remains a threat to Alphabet's business. Mobile computing is increasingly dominant, but around half of Google search queries still originate on the desktop, and desktop ads remain more lucrative. 

In October, Re/code reported that Alphabet plans to introduce a version of Android designed for traditional PCs next year. Alphabet's Chrome OS has attracted significant attention, but has failed to gain mainstream acceptance. Android-powered PCs could challenge Windows 10 for desktop dominance, and limit Microsoft's search gains.

In total, Bing generated just over $1 billion for Microsoft last quarter -- less than 5% of its adjusted quarterly revenue. But the steady evolution of Bing -- from notorious money pit to profit-driver -- is one of the more intriguing aspects of Microsoft's business. It likely won't dethrone Alphabet in the search space, but Windows 10 is slowly making Bing a legitimate contender.

Sam Mattera has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares) and Alphabet (C shares). We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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