Alphabet reported third-quarter results this week, and for the first time the search business gave investors a clear reason to worry about what AI is doing to it. Search and other advertising revenue was $63.4 billion, up 12% year over year and below the 15% analysts had forecast. The stock fell as much as 10% at one point.
On the earnings call, Chief Financial Officer Philipp Schindler explained the slowdown:
“the strong growth in AI mode queries had an impact because of the lower monetization”
AI Mode is the conversational search entry point Google has added to Search. Users get a model-generated answer directly, and there are fewer clickable ad slots than on a traditional results page. Management did not disclose usage figures for AI Mode or AI Overviews this time, and paid-click data was not broken out separately either.
The rest of the business
Total Google Services revenue was $96.3 billion, up 11%. Within that, YouTube ads brought in $11.2 billion, up 9%. Services operating income was $39.2 billion, a 40.7% margin.
The fastest-growing piece was the cloud. Google Cloud revenue hit $30.7 billion, compared with $15.2 billion a year earlier, a 103% increase. Operating income rose from $3.6 billion to $11.1 billion, lifting the margin from 23.7% to 36.2%. Cloud chief Thomas Kurian said he expects AI agents to keep driving cloud revenue growth.
On usage, the Gemini app has reached 1 billion users, and the API now processes nearly 32 billion tokens per minute, more than four times the level a year ago. Sundar Pichai said the company is working on a smaller, distilled version of its Carbon model to serve “billions” of users, which bears directly on cutting the cost of each AI Mode query.
A rough look at the two increments
Some back-of-the-envelope math from the reported figures. Search advertising a year ago was roughly $56.6 billion (estimated by dividing $63.4 billion by 1.12), so it added about $6.8 billion over the year. Google Cloud added about $15.5 billion over the same period, more than twice the search increment. Had search grown at the 15% the market expected, the quarter would have landed near $65.1 billion; the actual figure was about $1.7 billion lower, roughly a tenth of the cloud business's year-over-year increase this quarter.
In dollar terms, the shortfall is small. What worries investors is the direction. Search is still Alphabet's biggest source of profit, and the more people use AI Mode, the less advertising each query can sell. If that trend continues, growth will have to rest more heavily on cloud and subscriptions.
Capital spending is rising too. Alphabet spent $51.4 billion in the third quarter and kept its full-year guidance at $195 billion to $205 billion, while Schindler said 2027 would be “significantly higher.” Cloud's rapid growth and improving margins offset some of the market's doubts about that outlay, but the search slowdown puts the question back on the table.
What remains unanswered
Google did not say how ads are sold inside AI Mode, how much lower the unit price is than in traditional search, or what share of all searches AI Mode queries make up. If next quarter's report starts breaking out AI Mode ad revenue or click data, outsiders will be able to judge whether this is a transitional pain or a lasting change to the search business model. Until then, the market is left guessing from growth gaps of a percentage point or so.
Sources: Alphabet Q3 earnings report, The Decoder, CocoLoop, Alphabet earnings call; search advertising, Google Cloud revenue and capital expenditure figures were checked against the earnings report, and the year-ago base is an estimate.