Google struggling to make AI Mode searches pay

Alphabet, the parent company of Google, saw its shares plummet by nearly ten percent on Wednesday after the tech giant revealed that its AI-powered search engine, "AI Mode," generates less revenue than its traditional search engine. During its Q3 results presentation, Google reported a 12 percent year-over-year increase in search query growth, the highest it has seen in five years.

However, this growth came at a cost, as Google only earned $63.25 billion from search, a figure 14.5 percent lower than the 14.5 percent growth reported in the previous year's Q3.

The slowdown in AI Mode's monetization was attributed to Philipp Schindler, Alphabet's chief business officer, who stated that the issue stemmed from lower advertising revenue generated by the AI system. This concern is particularly significant, as Google has been investing heavily in infrastructure, spending $51.4 billion in Q3, with a significant portion allocated towards servers and networking equipment. The rest of the investment was used for datacenter construction.

Alphabet's net income for Q3 was $26.17 billion, which is significantly lower than the $35 billion net income generated in the same quarter last year. Google has been trying to monetize AI Mode searches by displaying ads alongside them globally, following a successful US-based test. However, despite these efforts, AI Mode searches have not proven to be as lucrative as Google's existing search engine, which contributed to just over half of Alphabet's $125.8 billion in quarterly revenue.

Google's cloud services, its next-best earner, generated $24.75 billion during the quarter. However, Google faces challenges in this area as well, as it struggles to meet the demand for its services. To address this issue, the company has started offloading some customer workloads to third-party providers and has warned that this move will impact future margins.

Thomas Kurian, Google Cloud's CEO, revealed that over 100 companies are utilizing the company's Tensor Processing Units (TPUs), and Google has committed contracts in place for the inventory related to these systems.

Despite the challenges, Google remains optimistic about the potential of AI revenue. Google CEO Sundar Pichai emphasized the rapid success of Google's Gemini app, which has garnered over a billion users faster than any other product in the company's history. Pichai also showcased the performance of Google's AI models and expressed plans to develop agentic AI tools, initially targeting business customers due to the high security, safety, and governance requirements.

Pichai did not provide a timeline for when agentic AI will be integrated into Google Search or address whether it will be able to avoid the monetization issues faced by AI Mode. The company, however, has reaffirmed its $195-$205 billion capital expenditure forecast for 2023 and expressed the intention to invest "significantly" more in 2027.