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Reuter/Arnd Wiegmann
You gotta spend money to make money.
CHA-CHING

Being Google is getting very expensive

By Ashley Rodriguez

Alphabet’s profit margins are thinning as the tech giant fights to maintain its advertising dominance and prove it’s more than a one-trick pony.

Operating margins at Alphabet narrowed to 21% during the fourth quarter of 2018, down from 24% a year ago, and 25% in the third quarter, Alphabet reported (pdf) on Monday (Feb. 4). The price of Alphabet’s class-A shares slipped around 3% in after-hours trading, when the report was released.

Revenue at Alphabet rose to $39.3 billion during the three month period, up 22% from the quarter a year earlier, and higher than analysts surveyed by FactSet had forecast. The company’s cash cow is still Google’s advertising business, which grew 20% from a year earlier to $32.6 billion. But Google is bringing in more from elsewhere, too. Revenue from Google’s cloud services, hardware, Play store, and other businesses generated $6.5 billion in revenue, a 31% increase year over year, and a solid 16% of Alphabet’s total revenue, compared to 14.5% a year earlier.

The top line growth wasn’t without cost, however. Cost of revenues at Alphabet rose 25% to $17.9 billion during the period from a year earlier. In short, it’s getting expensive for Google to be Google.

Much of those costs were from the fees Google pays companies like Apple to be the default search engine on iPhones and other devices, which are called traffic acquisition costs. Traffic acquisition costs jumped 15% to $7.4 billion during the fourth quarter. But Google, which generates an estimated 31% of all digital advertising revenue globally, according to eMarketer, can’t afford to give up such prime positioning when companies like Amazon are coming for its core business.

The increase was less than analysts expected, but still a sizable jump. Alphabet had been cautioning that traffic acquisition costs would rise as more of Google’s business shifts to mobile, which comes with higher fees than desktop. Traffic acquisition costs were about 23% of Google’s advertising revenue in the fourth quarter, in line with expectations.

Most of the other $10.5 billion in revenue costs went toward investing in content for YouTube, and its subscription-video offshoots YouTube Premium and YouTube TV, as well as growing Google’s cloud and hardware businesses, Ruth Porat, Alphabet’s chief financial officer, said on the company’s earnings call.

Meanwhile, losses at Alphabet’s other businesses, such as Fiber, Waymo, and Verily, kept piling up. Operating losses for “other bets,” as Google calls them, reached $1.3 billion during the period, a 77% increase year over year.