Microsoft and Google will duke it out over Silicon Valley's true financial driver: ads

• Much of Silicon Valley really runs on money from online ads.
• Google search dominated, but Microsoft's AI-powered Bing is emerging as a credible challenger.

For all the talk of driverless cars, internet drones, and the metaverse, Silicon Valley's biggest players rely heavily on one source of cash: online ads.

Companies spent about $400 billion dollars on online ads in 2022, per Dentsu, with Google taking about a quarter of that — outstripping competitors like Meta.

Google has dominated search and the search ad market for the almost 25 years since its inception. And curiously, its most serious challenger in that sector may not be Apple, Amazon, or Meta but Microsoft, whose new alliance with ChatGPT creator OpenAI is injecting new life into its Bing search engine.

Google's continued search monopoly looked inevitable. The company has around 90% of the search market, according to data firm Stat Counter. Google is so strongly correlated with how you navigate the web that it's been a verb for years, a byword for looking stuff up online.

But nothing is inevitable in tech, and a competing product equipped with next-gen AI is a problem if it gives users more informed responses to their questions. If Bing looks like the better option for users, this could reset the market for search ad dollars.

"The risk for Google is that Bing catches up as a product, and siphons usage away," Joseph Teasdale, Enders Analysis' head of tech told Insider.

As Insider's Lara O'Reilly writes, advertisers usually follow the eyeballs.

Anticipating battle, Nadella told The Verge this week that he hoped Google "will definitely want to come out and show they can dance."

Microsoft accounts for a tiny fraction of search ads

Around 40% of last year's digital ad revenue was generated from ads linked to search queries, analysts at Jefferies estimated in a note sent Tuesday.

Microsoft's share of the search ad market is small: it made nearly $18 billion in ad revenue last year, far smaller than the $224 billion Google made in gross ad revenue last year, the analysts wrote.

It means Microsoft has room to grow if it can truly make Bing compelling enough.

In a blogpost announcing the new Bing, Microsoft estimated about half of the 10 billion search queries made daily go unanswered as "people are using search to do things it wasn't originally designed to do." CEO Satya Nadella expects a ChatGPT-driven Bing to improve the fidelity of answers by giving users more insights and context to their queries, driving up gross margins in turn a little more each day.

Microsoft's chief vice president, Philippe Ockenden, said on a call announcing the upgrade that "the new Bing will have the context into what the user is trying to accomplish." That could help make ads more personalized and effective — enticing spend.

Still, success isn't guaranteed.

Microsoft will need to contend with what Jefferies analysts say is the higher computing cost of serving a GPT-powered answer.

And Enders' Teasdale notes that Google "delivers better results for advertisers, with higher click-through rates, particularly on mobile, and it commands higher prices, suggesting a higher proportion of clicks lead to conversion, or that conversions are more measurable."

Google doesn't just offer dominance in search, it has a sophisticated suite of ad products to serve customers.

Finally, the firm is also keen to show it can deal with conversational searches, taking the wraps off its own version of ChatGPT called Bard.

Declining ads market will spark fiercer competition

The fight coincides with a slump in ad sales, upping the pressure on Google is the dominant player.

Across the board, earnings reports from the major tech firms reflected a slowdown in revenue for all companies dependent on ads as advertisers slowed spending to adjust to the economic downturn.

Google's ad revenue in its fourth quarter came to $59 billion, marking a 3.6% year-on-year drop. The downward trend will be a significant concern for Google at a time when advertisers are being more frugal.

Meanwhile, Microsoft's Ockenden said on a call with analysts on Tuesday that "for every one point of share gain in the search advertising market, it's a $2 billion revenue opportunity for our advertising business."

Google will need to be battle ready.