Bing with AI is going to completely change what people can expect from search. We are grounded in the fact that Google dominates this space. I feel like a new race is starting with a complete new platform technology. I’m excited for the users to have choice finally, and a real competitive race out there

-Satya Nadella

CEO of Microsoft Corporation (MSFT) Satya Nadella turned the heat on Alphabet Inc. (GOOGL) in search and the latter’s stock lost 8% in a few days, especially after Google reportedly botched the event it held to respond to Microsoft’s new competitive threat. The quote above highlights Microsoft’s clear intent on upending Google as the leader in internet search.

While analysts focused on whether Google was winning or losing the AI race, this article will argue that Apple Inc. (NASDAQ:AAPL) could potentially be the biggest winner of this emerging competition in search. It will give a brief overview of the weapons both Microsoft and Google have at their disposal, and why Apple could end up being a key resource for both companies in the battle to win search.

Why Search is a Big Deal to Microsoft

As Nadella argues, search is « the most profitable category there is on planet earth. » A look at Google’s results for 2022 alone demonstrates this; the company reported a $162 billion in revenue associated with search. The market is projected to grow low-double digits in the next five years. It is also a high-margin business; operating margins on Google’s services business in Q4 of 2022 were north of 30%.

Google had virtually a monopoly over the market for a really long time. I believe that was due to two factors: first, the quality of Google’s search engine compared to peers. Second, the difficulty competing engines found in reaching users, particularly as more search queries move to mobile, where Google has the Android OS.

Apple is a key player in the search engine market, thanks to the large userbase of iPhone users that it possesses. The New York Times estimates that Apple receives a payment of $8 billion to $12 billion in annual payments from Google, in exchange for building the Google search engine into its products. The sum accounts for 14% to 21% of the company’s annual profits.

Microsoft now sees an opportunity to bridge the gap in quality, thanks to its investment in Open AI.

Microsoft Intent on Disrupting Google with Bing AI

Microsoft is betting that introducing AI to search can lead to a new product that disrupts how search is done in the future. It essentially combines the classical search that Google uses that involves displaying links to the search results, with an AI chatbot that can phrase the answer in its own words.

Google executives acknowledged that a conversational search engine « really strikes a need that people seem to have. » So Microsoft could be onto something.

Having a comparable or even a superior search engine isn’t enough, the challenge is getting users to switch from Google. This is where Apple comes in.

Apple Could Hold the Key to Microsoft’s Search Dominance

The percentage of search queries done from mobile is north of 60%. This is essentially where Google’s dominance in search comes from, given it owns Android which controls 70% of the smartphone OS market, and pays Apple (which essentially controls the remaining 30%) to build the Google search into its products. The fact that the mobile market is a duopoly and that most of search takes place on mobile means that emerging companies will find it hard to pry away users from Google. However, with Microsoft executives finally feeling they have a new search engine that could compete in terms of quality with Google, things could change dramatically. This quote from Satya Nadella is intriguing:

All I need is a few more users and someone else I’m competing in has to keep all of their users and all of their gross margin, right? it’s a lovely – I’m looking forward to that.

In the latest quarter, Google’s traffic acquisition costs were approximately 22% of advertising revenue. One of the quickest ways for Microsoft to disrupt Google isn’t just to integrate AI into search engines, but to outbid Google for Apple’s users. Like Nadella says in the quotes, every dollar of gross margin Microsoft gets is a dollar gained. It is Google that will be in the tough position of having to fend off competition while its advertising gross margins deteriorate.

For Apple, payments from Google have grown at a CAGR of 50%, as the latter looked to prevent Microsoft from outbidding it. There were fears by some Wall Street analysts that Google could revisit this strategy, knocking off at least 4% off of Apple’s gross profits. Here is the quote from Toni Sacconaghi in 2021:

We see two potential risks to GOOG’s payments to AAPL: (1) regulatory risk, which we believe is real, but likely years away; we see a potential 4-5% impact to Apple’s gross profits from an adverse ruling; & (2) that Google chooses to stop paying Apple to be the default search engine altogether, or looks to renegotiate terms and pay less. We have noted in prior research that GOOG is likely paying to ensure Microsoft doesn’t outbid it. That said, with payments likely to approach $18 – $20B in FY 22, it not implausible that Google could revisit its strategy.

With Microsoft unleashing an attack on Google’s search engine, one outcome is clear to me; Apple could be the clear winner in search without the benefit of hindsight. Google could end up fending-off the Microsoft challenge, or having its advertising margins permanently impaired. Microsoft for its part could succeed in dominating a new era for search, which could make it the most valuable company in the world in this case. But what seems clear to me for now is that the payments made to Apple by search engines (currently Google) in exchange to accessing its users are unlikely to stop, and could increase significantly if Microsoft enters a bidding war over them. That’s a beautiful position to be in for Apple shareholders.