Generative AI technologies are being suffused into a host of software applications aimed at businesses and consumers alike, and the financial results of all that investment are starting to show up.
A close reading of Alphabet’s and Microsoft’s third-quarter results shows that new AI tech is helping some of the world’s biggest companies grow their revenues. Even better, these companies are seeing AI growing in areas that are broad enough to indicate strong market demand for software that runs off generative AI. That’s good news for the plethora of startups building in the fast-expanding space.
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We’re going to cover a lot of positive news today, but the two companies’ reports yesterday engendered varying reactions from investors. Alphabet’s shares are down more than 8.5% this morning, while Microsoft’s stock is up nearly 4%.
This morning, I want to quickly parse the two tech companies’ earnings through the cloud and AI lens, and then glean what I can from their post-results conference calls. We’ll then apply all of it to startups at the end.
The demand for AI-powered tech is real
Alphabet’s revenue and net profit both beat street expectations, coming in at $76.69 billion and $1.55 per share, respectively. YouTube, a key source of advertising incomes at the search giant, also did well. However, Alphabet’s cloud revenue of $8.41 billion came in under expectations by around $20 million, CNBC reports. Investors did not like that at all.
Microsoft’s revenue and net profit also both beat street estimates, landing at $56.52 billion and $2.99 per share, respectively. Revenue from its “Intelligent Cloud” business group rose 21% year-on-year, including going up 29% at Azure, three percentage points better than analysts expected. Investors liked that a lot.
The market’s reaction to the two sets of data provides their grading, but we care about the AI-related components that went into the top-line numbers. This is due to the scale of both companies and the various market forces that impact their growth and profitability.
For our purposes, we want to zoom in on the impact AI is having on their results to arrive at some conclusions for startup founders. Starting with Alphabet’s conference call, here are some notes that stood out:
- Alphabet CEO Sundar Pichai: “From Q2 to Q3, the number of active Generative AI projects on Vertex AI grew by 7x, including Highmark Health, which is creating more personalized member materials.”
- Alphabet CFO Ruth Porat: “Turning to Google Cloud. We are pleased with the ongoing customer engagement with GCP and Workspace and the potential benefit of our AI solutions including infrastructure and services such as Vertex AI and Duet. We continue to invest aggressively given the significant potential we see while remaining focused on profitable growth. In terms of expenses and profitability, we’re pleased with our operating performance.”
- Google chief business officer Philipp Schindler: “Our AI tools are very well received. AI, Gen AI are top of mind for everybody, really. There’s a ton of excitement, lots of questions about it. Many understand the value. Nearly 80% of our advertisers already use at least one AI-powered search ads product.”
- Porat: “Finally, our reported CapEx in Q3 was $8 billion, driven overwhelmingly by investment in our technical infrastructure with the largest component for servers, followed by data centers, reflecting a meaningful increase in our investments in AI compute.”
Pichai’s comment implies that the number of generative AI projects on the Vertex AI platform are scaling from an initially modest base to something more material (more on Vertex AI here). That could imply some solid future revenue growth at Google Cloud, something that really does matter given that business performed worse than analysts expected in Q3.
Porat’s comment hints that the real revenue from generative AI at Google Cloud is still to come, however. Her note that her company is “pleased” with the “potential benefit of our AI solutions including infrastructure and services” is something to keep in mind for future quarters. When will that potential convert to actual revenue?
But not all revenue driven by AI is far in the future. Schindler’s comment on advertiser uptake of AI-powered search ads makes it clear that some of the overall Google quarter was boosted by AI.
Turning to Microsoft, here are the key bits from its analyst call:
- Microsoft CEO Satya Nadella: “Because of our overall differentiation, more than 18,000 organizations now use Azure OpenAI service, including new-to-Azure customers.”
- “We have over 1 million paid Copilot users and more than 37,000 organizations that subscribe to Copilot for business, up 40% quarter over quarter, with significant traction outside the United States.”
- “We see high demand for Security Copilot, the industry’s first and most advanced generative AI product. . . . And we look forward to bringing Copilot to hundreds of organizations in the coming months as part of the new early access program so they can improve the productivity of their own security operation centers and stop threats at machine speed. Higher-than-expected AI consumption contributed to revenue growth in Azure.”
- Microsoft CFO Amy Hood: “We’re excited for Microsoft 365 Copilot general availability on November 1 and expect the related revenue to grow gradually over time.”
- “While the trends from prior quarter continued, growth was ahead of expectations, primarily driven by increased GPU capacity and better-than-expected GPU utilization of our AI services, as well as slightly higher-than-expected growth in our per-user business.”
- “Capital expenditures, including finance leases, were $11.2 billion to support cloud demand, including investments to scale our AI infrastructure.”
- “Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability primarily from our per-user business and from in-period revenue recognition, depending on the mix of contracts. In Azure, we expect revenue growth to be 26% to 27% in constant currency with an increasing contribution from AI.”
There’s a lot here, so we’ll condense: First, the Microsoft-OpenAI deal is looking pretty tasty. New-to-Azure customers looking to use the cloud platform’s OpenAI services are providing incremental revenue lift. Mix in the fact that other customers are likely adding more to their cloud buying thanks to OpenAI’s prominence on the Microsoft infra mesh, and it looks even more bullish.
Next up: Copilots. GitHub’s own offering is now doing nine figures of ARR at 1 million seats and a $10 per-month price point. (Recall that GitHub’s head pushed back recently on reports that Copilot at the Git repository lost money on a per-user basis.) Elsewhere in the company, Security Copilot is going to see a far greater commercial footprint in the coming months, and in about a week, Microsoft 365 Copilot will become generally available. That means the possibility for Microsoft to generate marginal revenue from its AI investments is about to accelerate.
What does all that mean for startups?
Alphabet is seeing lots of demand for generative AI on its Vertex platform and strong advertiser update of AI-powered services. Microsoft is seeing customer appetite for assistive AI–related technology products in the realms of developer tools, cybersecurity, and productivity. That’s a pretty broad swath of the technology world.
I reckon that the hype for generative AI products and services is converting to real demand. For startups, many of which are working to either build their future atop new AI models or at least work the tech into their existing offerings, this is good news.
Of course we cannot say, “Microsoft is seeing AI-related demand in a product category; therefore startups will do well in that particular niche.” But the existence of demand implies that startups in various niches of the software world have a good chance of selling to enough customers.
Of course, all that depends on the major cloud providers not being greedy and sucking all the demand out of the room. That is something we’ll have to wait to better understand.
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