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Why Alphabet’s Profit Margin Is Shrinking

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Google’s traffic costs are soaring

As Alphabet’s (GOOGL) Google combats the escalating competition in the digital advertising market, it is finding that running its advertising business has become more expensive. Alphabet’s total costs and expenses rose 25.9% YoY (year-over-year) to $31.1 billion in the fourth quarter, driven by higher spending on traffic acquisition, product development, and marketing. Google’s traffic acquisition costs rose 13.8% YoY to $7.4 billion, consuming 23% of its advertising revenue. Meanwhile, Baidu’s (BIDU) traffic acquisition costs comprised less than 16% of its advertising revenue.

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Rising costs hit profit margins

Rising costs and expenses at Alphabet pressured its operating margin in the December quarter, narrowing it YoY to 21% from 24%. Facebook’s (FB) and Baidu’s operating margins have also shrunk in recent quarters as they have responded to escalating competition in their industries by boosting spending on product development and marketing. Facebook faces immense competition from Twitter (TWTR) and Snap (SNAP) in the pursuit of younger social network users and marketers’ Millennial-focused advertising budgets.

Although Google’s rising traffic costs have caught investors’ attention to the point of some worrying that the company may be spending too much to run its most important business, the company sees no cause for alarm. In the company’s fourth-quarter earnings call, Alphabet CFO Ruth Porat said traffic costs are rising with the ongoing shift to mobile, but growing advertising sales are making up for the higher traffic spending.

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