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Earnings Call Transcript

Earnings Call Transcript

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Welcome everyone, and thank you for standing by for the Alphabet Q3 2021 Earnings C conference Call. At this time, all participants are in listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator instructions] I'd now like to turn the conference over to your speaker today, Jim Friedland, Director of Investor Relations. Please go ahead.

Jim Friedland
Director, Investor Relations

Thank you. Good afternoon, everyone, and welcome to Alphabet's third quarter 2021 earnings conference call. With us today are Sundar Pichai, Philipp Schindler, and Ruth Porat. Now, I'll quickly cover the Safe Harbor. Some of the statements that we make today regarding our business operations and financial performance, including the effect of the COVID-19 pandemic on those areas, may be considered forward-looking.

And such statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our most recent Forms 10-K and 10-Q filed with the SEC. During this call, we'll present both GAAP and non-GAAP financial measures.

A reconciliation of non-GAAP GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at ABC investor. And now, I will turn the call over to Sundar.

Sundar Pichai
Chief Executive Officer

Thank you, Jim. And good afternoon, everyone. In 2016, I laid out our vision to become an AI first Company. Five years later, this quarter's results show how our investments in AI are building more healthful products for people and for our partners in local communities. Today, I'll begin with new product highlights.

Then I'll cover our cloud business, followed by YouTube. First product highlights. Search remains the heart of what we do. We have made remarkable advances over the past 23 years that benefit search and related products like Google Assistant. We have just celebrated five years.

Earlier this year, we announced that we reached a significant milestone with Multitask Unified Model, or MUM for short. MUM is a thousand times more powerful than BERT and can understand information across many contexts, like text and images.

On our search event in September, we shared how we are using MUM theme through Google Lens, so people can search using both images and words. We also shared that we are bringing a more visual shopping experience to search, powered by Google Shopping graph. It linked shoppers with over 24 billion product listings from merchants across the graph.

Google Maps now offers eco -friendly routing. It lets drivers in the U.S. to some more fuel-efficient route, saving money and reducing emissions. Maps now has a wildfire layer so that people can get up today details and make quick, informed decisions during emergencies.

Finally, in search and us discover feed, we're continuing to support the news eco system and make quality journalism more accessible. Philipp will give a bit more detail about our new showcase partnerships. Turning next to hardware, I hope you saw our fall P pixel event last week.

I am very excited about the range of Pixel phones available this holiday season. The new Pixel 6 and 6 Pro brings together the best of Google AI, software and hardware at the most advanced and inclusive cameras we've ever.

They are beautiful, fast, and powered by Google Tensor, a first-ever system-on-a-chip. It's specifically built to support Google AI and machine learning on device, and provide s a long-term foundation for our Pixel devices. We also introduced our new Nest for a [Indiscernible] program, which uses Nest Thermostats to support clean energy use in the home.

On to Android, Android 12 is getting great reviews. It's the biggest design change in Android's history with new widgets to personalize your phone. We also introduced accessibility features that use gestures to control your phone and communicate.

Android 12 is secured by default and private by design. New dashboards and the indicators make it easier to view and adjust privacy permissions and disable access to device sensors and location information. We've also made progress with the made for India affordable smartphone co-developed with Reliance.

The Geophone next device features premium localized capabilities and is on track to launch in-market by Diwali. Onto cloud, where we see continued momentum with Q3 revenue growing 45% year-over-year with GCP's revenue growth rate about Cloud overall. At Cloud next two weeks ago, we unveiled 100s of new capabilities, services, and solutions.

We also announced 20 new and expanded partnerships to support the growth and scale of our customers around the world. More than any other top cloud provider. Google Cloud has unique capabilities to meet the needs of enterprises, digital natives, and SMB around the world. I'll highlight three.

First, our leadership in real time data, analytics in AI, is winning customers like Carrefour Belgium, [Indiscernible] Post, DHL, and Wendy's, who are unlocking data to deliver unique business outcomes. Big Query, our leading data warehouse solution is reducing costs and driving productivity at Cardinal Health and ATB Financial. Our differentiated AI in mall-based industry solutions are helping leading global companies.

GE Appliances, a higher Company is integrating Vision AI into their next-generation smart home appliances. And Ikea Retail is using recommendation AI to drive a 30% increase in customer click-through rate. Second, customers see value in our open scalable infrastructure that enables them to run workloads anywhere on our cloud, at the edge, or in their datacenters.

Rodan + Fields scale, it's says SAP environment, Siemens Energy migrating its global network of datacenters and Company-wide SAP systems. And Indonesia's largest technology, digital native, go-to group is supporting over a 100 million monthly active users with Google Cloud.

General Mills, Bell Canada, and Wells Fargo are harnessing our leadership in multi-cloud and our open development environment. And to meet the unique digital sovereignty needs of customers around the world, we announced industry first partnerships with T-Systems in Germany and Palace in France.

Third, as consumers, businesses, and schools continue to shift towards hybrid work, the threats of cyber security continue to increase. Customers are turning to Google Workspace and our cyber security platform to provide the ease of use, collaboration, and security they need.

These include organizations like Discovery, Common Spirit Health, and the state of Maryland who want to foster creativity while securely protecting their users. We're also seeing strong growth in our broad portfolio of cyber security products.

This includes Chronicle, one of our zero-trust offerings, with JetBlue users to detect cyber security threats, helping to protect its customers and enterprise. We're bringing our team's deep expertise to customers through the Google Cyber Security action team and a new Work Safer program, which provides best-in-class security for emails, meetings, messaging, and more.

Earlier, I mentioned a few of the sustainability-related product features we announced. Our Cloud customers already benefit from operating on the world's cleanest cloud and last year we set an ambitious goal to run our data centers and campuses on 24/7 carbon-free energy by 2030.

Two - thirds of the electricity consumed by Google data centers in 2020 was matched with local carbon-free sources on an hourly basis. And our new carbon footprint tool gives customers carbon emissions insights associated with their Google Cloud Platform usage.

Now over to YouTube for a few highlights. We recently surpassed 50 million music and premium subscribers, including those in trial. And YouTube shots continues to see higher option rates. In the past year, the average number of daily first-time creators more than doubled. Next week as global leaders gather in Glasgow to address climate change, YouTube is partnering with COP26 to livestream conference activities, making the event more accessible for everyone.

As we grow, we are maintaining our open global platform responsibly by removing harmful content and reducing bottom-line content. Both our AI investments and the promotion of Clustered sources have helped us significantly lower the violated view rate, which is the percentage of views on YouTube from content that violates our policies. Onto our other bets.

Waymo began welcoming riders to its trusted tester program in San Francisco in addition to its fully autonomous ride-hailing service currently in Phoenix. Next year, Waymo will open a dedicated trucking hub in the Dallas Fort Worth area, helping support commercial freight droughts across the Southwest.

And we announced last week the first commercial expansion of things on demand, air delivery service to Walgreens customers in select locations. To close, the world is slowly starting to travel and meet up in-person. In this quarter, I joined events virtually to celebrate some big milestones in regions around the world. Earlier this month, we announced a $1 billion investment in Africa over five-years to support the continent's digital transformation.

And September mark 20 years since we opened our first office outside of the U.S. in Tokyo. We now have thousands of employees in 28 offices across the Asia Pacific region. And we are investing in cloud regions and digital skills programs to help expand economic opportunity there.

As you can see, our business in APAC is growing really well. in Africa, Asia Pacific and beyond it's been a successful quarter and we have lots more innovation and product development on the way. Thanks to our employees around the world for their contributions. As we continue our [Indiscernible] to hybrid work, I hope to see more of you in person soon. Thank you and over to Philipp.

Philipp Schindler
Senior Vice President and Chief Business Officer

Thanks, Sundar, and hi, everyone. It's great to be with you all today. We are pleased with the growth in Google Services revenues in the third quarter. Year-on-year performance was driven by broad-based strength and advertisers spend. Consumer online activity also remained elevated. In the third quarter, Retail was, again, by far the largest contributor to year-on-year of our Apps business.

Media and entertainment, finance, and travel were also strong contributors. Let's take a deeper look at some of the trends that drove this quarter's performance. First, from a big picture global recovery perspective, we continue to see a lot of unevenness. Some economies have restarted and re-accelerated or be at different speeds.

Other countries, depending on local regulations and vaccines, have been slower to rebound. It's clear that uncertainty is the new normal. The world is in flux. So, when it comes to anticipating change, predicting demand, and investing in innovation, businesses need as much support now as they did a year-and-a-half ago.

And we continue to help, like in travel, where hotel free booking links are increasing traffic for many partners from OTAs to boutique hotels. Consumers like more choice. Travel partners like free exposure.

Jim Friedland
Director, Investor Relations

And advertisers like to augment paid campaigns with free listings. So last month we launched free [Indiscernible] for things to do, and a new ad format that makes it easier to promote local experiences.

Now, when you search zip lining, aquariums, or the Tokyo Tower, you can buy tickets directly on Google. And then there are companies like Alaska Airlines that are harnessing first-party data and automation across search to navigate market fluidity and better understand the lifetime value of their customers.

They have increased return on ad spend by 30% plus versus the same period pre COVID, beyond travel. Business of all kinds are increasingly adopting tools like AI driven automation and insights to connect with customers. No matter what stage of the recovery there in. 150-year-old luxury retailer

Philipp Schindler
Senior Vice President and Chief Business Officer

De Bijenkorf turned to local insights and automation to speed up cross-border expansion beyond the Netherlands and Belgium to Germany, France, and Austria. With a multi-pronged approach, including Shopping campaigns, de Bijenkorf drove substantial growth throughout the pandemic.

Returning visitors to online stores, were up fourfold in first half 2021 versus 2020, which leads me to Retail, where we had another stellar quarter. We've seen explosive growth in Digital over the last 27 months. But as the world begins to reopen, shoppers are returning to stores. Brick and mortar aren’t dead. Instead, omni -channel is in full force.

Searches for open now near me are four times globally versus last year. Strong growth in Local Shopping queries means people are researching the visits to stores more often before they go. As a result, we've seen more advertisers include in-store sales alongside e-commerce goals to drive omni -channel growth. Adoption has nearly doubled over the past year.

Take COTS, it optimizes media spend into trending categories and launched curbside pickup just two weeks after its 1100 stores shutdown. After testing local inventory ads in Q4, COTS went all-in on omni -channel bidding across its paid search portfolio and is leaning heavily into a full funnel approach on YouTube, including CTV. COTS (ph.) net sales were up 31% year-over-year in Q2, led by higher foot traffic and continued strength in digital.

Innovating an omni -channel and next-gen user experiences remains core to our Shopping strategy. A few of our latest launches include easier ways for business to show the local services they offer, from hair extensions to auto repair, across Search and Maps.

Local inventory ads, it highlights which products are in stock and when to pick them up. Free shipping and easy return annotations across search and Shopping, AI capabilities that bring in-store moments online and that users try before they buy, and then instantly shoppable images with Google Lens, plus a new visual, browsable experience on Search.

There's a lot more to come, including tapping into commerce on YouTube. from shoppable livestream experiments with retailers like, Sephora, Target and Walmart. To pilots that, that viewers by directly from the favorite creators’ videos we're still in the early innings of what’s possible.

Our direct response momentum remains strong, video action campaigns are driving more conversions than previous formats, and by adding product feeds to these campaigns, advertisers are achieving on average, over 60% more conversions at a lower cost than those without. Our brand business is also performing well.

As I said last quarter, YouTube's reach is becoming increasingly incremental to TV. We're helping advertisers find audiences they can't find anywhere else. Connected TV is driving part of this growth, is our fastest-growing screen. The precision of digital paired with the scale of linear is proving to be an awesome combo.

And even more so now with the expansion of video action campaigns for CTV. Advertisers can now drive conversions on the big screen, which brings me to help brands of all sizes continue to buy YouTube at both ends of the funnel to create future demand while they convert existing demand. And they're seeing upside.

For example, we found that advertisers using both DR And brand video see brands driving 28% of conversion assists. Domino's Pizza is a great example. the UK business delivered a 9x return on ad spend on their direct response campaigns when paired with our brand campaigns. Lastly, I've said it before, and I'll say it again: our success is only possible because of our customers and partners.

We do well only when they do well. And it's a result of the revenue share models we've talked about many times before. Three highlights, first, as Sundar mentioned, our commitment to high-quality journalism and open access to information remains steadfast. It's been one year since we launched new showcase.

In Q3 alone, we signed over 120 deals and launched in three new markets, Japan, Colombia, and Austria. And of the more than 1,000 publications across a dozen-plus countries that we now have on board, 90% are considered local, regional, or community newspapers.

Second, over 2 million creators are now making money and building their businesses on YouTube via YouTube Partner Program with 10 different ways to monetize their content from Super Chat to Brand Connect. The next-generation of businesses and media companies are being built by creators on YouTube and we're excited to help them grow. Third by echoes Sundar's excitement on Pixel, and to bring it to life and to users, we worked with an entire ecosystem of partners.

We signed partnership agreements with over 45 carriers and retailers across 9 countries at launch, including deep collaboration, with each of the major U.S. carriers AT&T, T-Mobile and Verizon. On behalf of many. I want to say how grateful we are to collaborate with so many amazing customers and partners every day.

We can't wait to start doing more of this in person again soon. Also, a huge thank you to our sales partnerships, product and support teams for their work and dedication. The impact you all continue to have is, as we say in Germany, [inaudible 00:18:32], with that Ruth over to you.

Ruth Porat
Chief Financial Officer

Thank you, Philipp. Our revenue performance in the third quarter reflects continued broad-based strength in advertisers spend and elevated consumer online activity, as well as a strong contribution from Google Cloud.

My comments will be on a year-over-year comparison for the third quarter unless I state otherwise. We will start with results at the Alphabet level, followed by segment results, and conclude with our outlook. For the third quarter, our consolidated revenues were 65.1 billion, up 41% or up 39% in constant currency.

Our total cost of revenues was 27.6 billion, up 31% primarily driven by growth in TAC, which was 11.5 billion up 41%. Other cost of revenues was 16.1 billion, up 24%, reflecting in part the benefit from the change in useful lives meet earlier this year.

The largest driver of the growth in other cost of revenues was content acquisition costs. Operating expenses were 16.5 billion, up 19%, in terms of the 3 component parts of opex. First, the increase in R&D expenses was driven primarily by headcount growth.

Second, the growth in sales and marketing expenses was driven by headcount growth, followed by the continued ramp up of spending on ads and promo, in contrast to the pullback in the third quarter last year. Finally, the increase in G&A reflects the impact of charges relating to legal matters, followed by headcount growth.

Operating income was 21 billion, up 88%, and our operating margin was 32%. Other income and expense were 2 billion, which primarily reflects unrealized gains in the value of investments in equity securities. Net income was 18.9 billion. We continue to generate strong free cash flow of 18.7 billion in the quarter and 65.7 billion for the trailing 12 months.

We ended the third quarter with 142 billion in cash and marketable securities. Let me now turn to our segment financial results, starting with our Google Services segment. Total Google Services revenues were 59.9 billion, up 41%. Google Search and other advertising revenues of 37.9 billion in the quarter were up 44% with broad-based strength across our business, led again by strong growth in retail.

YouTube advertising revenues of 7.2 billion, were up 43% due to strength in both direct response and brand advertising. The deceleration in the growth rate versus the second quarter was driven by lapping a strong recovery in brand in the third quarter of last year. Network advertising revenues of 8 billion were up 40%.

Other revenues were 6.8 billion up 23% driven by growth in YouTube non-advertising revenues and hardware which benefited from the addition of Fitbit revenues. Google Services operating income was 24 billion, up 66%, and the operating margin was 40%. Turning to the Google Cloud segment, revenues were 5 billion for the third quarter, up 45%.

GCP's revenue growth was again above Cloud overall, reflecting significant growth in both infrastructure and platform services. Strong revenue growth in Google Workspace was driven by robust growth in both seats and average revenue per seat. Google Cloud had an operating loss of 644 million.

As to our other bets in the third quarter, revenues were 182 million, the operating loss was 1.3 billion. Let me close with some comments on our outlook. With respect to foreign exchange impact on reported revenues, based on current spot rates, we expect virtually no impact in Q4, in contrast to 1.5% tailwind in Q3 and 4% in Q2. In terms of outlook by segment.

For Google Services, as I noted, the strength of our revenues in Q3 reflected both underlying strength in advertiser and user activity, as well as the impact from lapping weaker performance in the comparable period last year.

Given the gradual recovery in results through the back half of 2020, the benefit from lapping prior year performance diminished in Q3 versus Q2 and will diminish further in Q4. Within other revenues in the fourth quarter, we expect the ongoing drivers of revenue growth to the Hardware due to the benefit from the holiday selling season and inclusion of Fitbit, as well as YouTube subscriptions.

Google Play's contribution to revenue growth will remain more muted given the ongoing impact of both lapping the increased level of user engagement that started in the first quarter of 2020 due to the pandemic, as well as the fee change that took effect on July 1. Within Google Services, we expect sales and marketing expenses to be elevated in the fourth quarter to support the holiday season.

Turning to Google Cloud, we remain focused on revenue growth and are pleased with the trends we're seeing. In GCP, our customer wins, as Sundar noted, reflect our multi-year investments in products and solutions that are purpose-built to solve for the biggest opportunities within our targeted 8 industries.

The benefit of these solutions to our customers is clear, and they are choosing to work with us as their long-term transformation partner. With respect to workspace, we are pleased with the ongoing momentum in both seat growth and average revenue per seat, which underscores the value of collaborative solutions, in particular, as people increasingly are embracing a hybrid work model.

Across cloud, we continue to invest aggressively, both in growing our go-to-market and product teams, as well as building out our cloud regions. At the Alphabet level, headcount grew by nearly 6,000 in the third quarter, including our seasonal campus hires.

And we expect robust headcount growth in Q4 for both Google Services and Google Cloud. Turning to CAPEX, the results in the third quarter primarily reflect ongoing investment in our technical infrastructure, most notably in servers to support ongoing growth in Google Services and Google Cloud.

We also continue to increase the pace of investment in fit-outs and ground-up construction of office facilities to accommodate our ongoing headcount growth globally. We will continue to pursue real estate acquisition opportunities where it makes sense, as you saw in our New York City announcement in Q3. Thank you. And now, Sundar, Philipp, and I will take your questions.


Thank you. [Operator Instructions] And our first question comes from Eric Sheridan from Goldman Sachs. Your line is now open.

Eric Sheridan
Goldman Sachs

Thank you very much for taking the questions. Maybe first one for Sundar, a big picture. Coming back to how you started the call, when you look out over the next three to five years, what do you see are some of the big investments that Google needs to make to marry your ambitions on AI, machine learning against aligning Google's broader product and services against the rising digitalization of the global economy. Would love to have that as a framing over the next three to five years.

And then maybe -- I am not sure if directed better at Philipp or Ruth, but on a shorter duration basis, it seems to be an element of headwinds and tailwinds in the broader, can you talk a little bit about the business elements of Google's products and what elements of reopening dynamic you're seeing on a sector basis versus potential headwinds as we move into Q4 and next year from things like supply chain shortages, or labor shortages, or things like that. Thanks so much in advance for the color.

Sundar Pichai
Chief Executive Officer

Eric. Great question. You're right in the fact that AI and ML itself is broader, deeper investments we are driving, and we're using it across our product portfolio. The recent launch of Tensor in Pixel six a great example of that.

So, for example, we're willing to go as steep in the stack as needed. Silicon both on the cloud side with our Tensor Processing Units and Google Tensor on the client side is an example of that. Overall, thinking through computer, networking, building data centers, making sure they are clean and carbon-free, and really investing in the advanced models and algorithms on top, which is a lot of it just done by our AI research teams.

So, making sure we're able to attract the best talent across the world is all part of that. So, but you you'll continue to me to see us undertake deep technology investments and beyond the horizon. That's why we're thinking even about areas like quantum computing and so on.

Philipp Schindler
Senior Vice President and Chief Business Officer

So, to the second part of your question, we continue to watch countries as vaccination rates climb and local regulations ease. We expect some amount of heterogeneity in recovery depending obviously on location and vaccination rates. But because every region is different, it's hard to make a generalization from the data right now. That said, the consumer shift to digital is real and will continue even as we start seeing people return to stores.

Shopping habits have ebbed and flowed over the last 20 months. But the underlying takeaway is that people want more choice. They want more information, more flexibility, and we don't see this reversing. Omni -channel, I talked about it, is definitely in full force. I said this earlier. We've been really focused on building features and solutions to help retailers, large and small, succeed here.

And we think this will continue as the world reopens, and shoppers fluctuate between online and in-store based on whatever is really more convenient. YouTube is exciting for many reasons. It's incredible to see lot of content that's valuable for people across so many topics, and we're helping advertisers tap into this.

And whether it's browsing for inspiration, product research or actually making the purchase a billion shopping sessions happen across Google every day, and they are happening on search, in YouTube, in image search, in the shopping tab, on Lens, and so on. So frankly, we are really encouraged by the long-term opportunity in commerce, and we are laser focused on helping business of all sizes connect with their customers

Sundar Pichai
Chief Executive Officer

wherever they are.


Thank you. And our next question comes from Brian Nowak from Morgan Stanley. Your line is now open.

Brenda Ell
Morgan Stanley

Hi. It's Brenda on for Brian. Thanks for taking our questions. We have two. The first one, you've made notable strides in the retail search category over the past 12 to 18 months, and there seems to be more to come. Can you talk to us about which other search verticals, where you are most excited to innovate and invest around the Nest, within the next year or two? My second question is, maybe one on augmented reality.

You have made some real progress here and I have some budding product integrations. Philosophically, how do you think about the key augmented reality use cases you are focused on enabling? And do you need an Alphabet specific hardware set to capitalize on the opportunities? Thank you.

Sundar Pichai
Chief Executive Officer

I'll take the second one first. On augmented reality, we've -- for a while, we've deeply focused on thinking through computing for the long-term. We've talked about ambient computing, and it's just a matter of time before beyond phones, you will see other successful form factors and AI is an exciting part of that future. We are looking at all deep investments, we need to make. I think it's going to take some time.

And so, for example, when you look at something like Google Lens or when you look at the fact that we are making search work in a multimodal way, or when you think about YouTube and making sure it works well. We are AI world so we are, obviously, investing in all our services.

And beyond that from a computing standpoint, both our hardware teams as well as our platform teams are thinking through definitely, and it's going to be a major area of investment for us. On the first question, I think Philipp spoke about Shopping via, obviously, searches -- part of what makes S search so successful is people use it for a wide variety of use cases.

And so, we really invest comprehensively across all experiences, be it Local and Maps, be it images, be it videos. And so, we're definitely investing a lot. People do come to search for education as well, so making sure we're comprehensive.

Health has been a major area of focus, particularly through the pandemic. And so, the strength of searches both in its depth and breadth and so, and then getting it tried with high focus on quality and will continue to do that.


Thank you. And our next question comes from Doug Anmuth from JPMorgan. Your line is now open.

Doug Anmuth

Thanks for taking the questions. I've two. First, was just curious if you're seeing any impact at all from the Apple iOS changes in your business and perhaps particularly in YouTube. And then second, given Retail, the biggest driver of services growth, and of course, you are really just touching all parts of the economy, any more commentary on how you're thinking about supply and labor shortage dynamics in the fourth quarter, and if you're perhaps seeing anything thus far there? Thank you.

Ruth Porat
Chief Financial Officer

Thanks for the question. Starting with the iOS 14 changes. So overall, as we said, we're pleased with the strength across our business in the third quarter, it was broad-based, it was global. In terms of the iOS 14 changes, specifically, they had a modest impact on YouTube revenues, that was primarily in direct response. I think as you all know well, focusing on privacy has been core to what we've been doing consistently. Let me have Phil take you through some more on that.

Philipp Schindler
Senior Vice President and Chief Business Officer

So, from our standpoint, we see ATT (ph.) is one aspect of the many broader ecosystem changes that are on the way, and we've been investing in privacy preserving technology for many years. Our focus is on supporting developers, small and large advertisers, creators’ publishers, so that they're able to mitigate impact to their businesses.

And we really see the future of digital advertising being built on advances and privacy preserving on device technologies which support the free and open Internet. And obviously, a robust ads ecosystem on your supply chain questions. I would say performance in Q3 was strong across revenue lines, regions, and nearly all verticals.

In line with the widespread reporting of supply chain weakness in the audit industry, we've seen some impact on vehicles within the auto vertical which started earlier in the year, although the impact has really been offset somewhat by increased demand in related areas like parts, accessories, repairs, and maintenance.

Unidentified Analyst

Great. Thank you.


Our next question comes from Q - Justin Post from Bank of America. Your line is now open.

Justin Post
Bank of Ameri ca

Thank you. One for Sundar, one for Ruth. Sundar, margins have been strong this year and I think the depreciation change has helped. Can you just comment on how you see the current investing spending levels of the Company? Are you in good shape? Anything where you might be increasing investment.

And then for Ruth, there are news about Play Store fee cuts on the subscription piece. How do we think about that maybe impacting the business in '22 when those start to take effect? Thank you.

Sundar Pichai
Chief Executive Officer

Now, at a high level -- look, i mean, I have taken a long-term view, and we're obviously investing both in foundational technologies, like AI and just deeper computer science. So, we're all in in applying it across the prioritize set of areas. And so, no change in the framework, if anything.

I do feel with the digital transformation underway, if anything, we feel a sense of urgency to execute against opportunities we see. So still working within the long-term framework, maybe. Ruth and Philipp?

Ruth Porat
Chief Financial Officer

Yeah. if I can just add on the margin and go to your second part of the question, just a bit of context on the third quarter here. An important point, hopefully self-evident, is that the improvement in the Q3 operating margin does reflect the strong revenue growth in the quarter.

And as I said on the second quarter call, some of our costs are less variable in the short-term, such as depreciation and the operations costs of our data centers. And we did have a gross margin benefit from this in the near term, but consistent with centers comments [Indiscernible] we do continue to invest here.

And then to support long-term growth across both Google S services and Google Cloud, we're continuing to invest at a meaningful clip across headcount, compute sales and marketing. I noted that headcount increase in Q3 of about 6,000 and we do expect the pace of hiring to remain strong.

The benefit from the change in useful lives was obviously in the quarter as well and that benefit does diminish is lower in the fourth quarter. So just to put some of that in context, and as Sundar said, we are continuing to invest in the business focusing on long-term growth, with respect to the play changes.

Again, just as it relates to this quarter, and I think as I said, in opening comments, the key point to note there was that results lap the strength that we had going into the pandemic from user engagement, and that continues to seeing user engagement. But yes, there's a reduction in the fee that kicks in, one that we just announced last week, it kicks in as of January 2022, and we'll let you do the modeling on that.

Justin Post
Bank of Ameri ca

Thank you.


And our next question comes from Mark Mahaney from ISI. Your line is now open.

Mark Mahaney

Thanks. Two questions. Is there anything that suggest that some of these ATT headwinds for other people in the industry actually cost shifts in budget over to your platforms, your different platforms? And then, as for Philipp and Ruth, just on the margins.

Is there anything other than revenue overage that really strong revenue performance flowing against fixed costs and the extended depreciation schedules that's causing those margins to rise or have you been able to work out, eke out, tweak out new efficiencies in the model itself? Thank you very much.

Ruth Porat
Chief Financial Officer

So why don't I start on that? The key points, as I said, starts with strong revenue growth and just timing lags. If some of the costs, as I said, are more fixed in the near-term, but we do continue to invest. And you can see that in gross margin. You can see it in operating margin. We are continuing to invest to support growth we see in both Google Services and Google Cloud.

Up leveling the question, we've consistently said, let's look, we our focus on capital allocation is investing for long-term growth and innovation and making sure that we remain focused. on that though, those long-term opportunities. At the same time, we've consistently also said that it's important to ensure that we're being sharp about investments within each product area, and we're continuing to do that.

And we're continuing to focus on investing in what we call operational excellence to ensure we can deliver for all of our stakeholders in a high-quality way. And that includes all of our efforts around privacy, security, and content moderation. So, you're seeing us continue to invest there. A bit of puts and takes. We're trying to ensure that we're setting up all of the areas to deliver for long-term high-quality performance and results.

Sundar Pichai
Chief Executive Officer

On the first question around ad budgets and shift and stuff, I don't think there's anything notable that we have observed to comment on.

Mark Mahaney

Okay. Thank you very much.


Thank you. And our next question comes from Brent Thill from Jefferies. Your line is now open.

Brent Thill

Thanks. On Google Cloud, we continue to hear from the partners that the deal size is building, and Big Query is having a big impact for a lot of your customers. Can you just talk to and expand on what you're seeing there and any other noticeable trends that you're seeing now that maybe you hadn't seen in the past? Thank you.

Sundar Pichai
Chief Executive Officer

Thanks. Look, overall, we continue to see strong momentum. The team is executing well. You mentioned Big Query, Data and Analytics, and AI, continues to be a foundational shift for what companies are trying to completion, and Big Query does stand out there and we're definitely seeing continued momentum, there is a source of strength.

To other areas, I would highlight our Security continues to be an increasing area of focus and a differentiator for us, given over two decades of investment we've had. We've pioneered "zero trust" and so on.

So as cybersecurity elevates and consent across companies I talk to and the CEOs, it's definitely been an area. Multi-cloud continues to be a differentiator, I do think customers are increasingly looking for it and we've embraced it from early on so that is an area as well.

But above all, I think we're very, very focused on industry value propositions, so really sharpening our solutions by vertical and that's really helped us get some of the bigger deals you mentioned as well. And we'll continue doing that. Thank you.


Thank you. And our next question comes from Michael Nathanson from c. Your line is now open.

Michael Nathanson
Michael Nathanson

Thanks. I've had one for Sundar and one for Porat. Sundar, you talked earlier about the Geo-phone next in the launch, next week, in India. I wonder if you can talk about the Walmart turned opportunity for Alphabet India, where you're from opening up that product in any type of time frame when do you think you will see maybe the benefits of what you're doing on the low price on there.

And then it just seems longer-term as more we're targeting becomes more difficult to all these privacy changes. There has to be a mix shift in budgets.

I wonder, how do you think the value proposition of search will change going forward and what can you do even more than you've done before to take advantage of what looks like real challenges and the ability to target and measure becomes the mobile search. I mean when it comes to mobile advertising.

Thanks. [inaudible 00:42:37], thanks for the question. Look, I think, obviously, the pandemic has been hard. But a through it all, people are looking for access, and this definitely being available for people who have adopted smartphones. There is still -- we see the demand for people looking to shift from feature phones to

Sundar Pichai
Chief Executive Officer

smartphones. And so, part of what excites me about the upcoming partnership with GO in building a phone is really investing beyond just English, and getting languages, and getting the local needs right for people and doing it in a way that many more people can take advantages of a smartphone.

So, I view it as laying the foundation to version of digital transformation and its palpable demand we see and I think over a three to five-year time frame, it will end up having a lot of impact. But overall, India, just like Asia Pacific, continues to be an exciting market for us. We see strength across the categories we are involved in. And so, you'll continue to see us stay focused there.

And to the second part of your question, look, as I said, we see the future of digital advertising being built on advances in privacy-preserving on device technologies. And this is a big area that we've invested already and that we're going to invest in even more. And as far as how we think about our runway for growth, we really think about improving user and advertiser experience for years and years to come.

And we're always asking ourselves the same questions, right? How do we drive better answers to queries especially on search, especially including those with commercial intent? How do you use machine learning to deliver even more relevant and higher-quality experiences for users that drive higher clicks and more conversions for advertisers?

So really our main goal is to consistently deliver great experiences for users, drive incremental value for partners, and making them successful. And as long as we do this, and we continue to invest in the privacy-preserving technologies I mentioned, we should continue to see budgets move our way. Okay. Thank you.


Thank you. Our next question comes from Ross Sandler from Barclays. Your line is now open.

Ross Sandler

Hey guys, I just have a high-level question on YouTube. So, you're obviously doing really well there, and as large as it is and as high as the engagement is compared to just about any other app that we see across the broader Internet, the revenue at just around 30 billion this year pales in comparison to co re Facebook or Instagram. So, do you think this -- this is obviously a huge opportunity for YouTube, especially with connected TV.

Is there something that you guys need to change about your approach with either direct sales or kind of decoupling search from YouTube and some of the other products that Google has under the same roof, or do you think continuing along the same path is the right strategy for YouTube specifically? Any color on that would be helpful.

Sundar Pichai
Chief Executive Officer

Obviously, YouTube is unique in the sense that it's a true video -- native video-first product from day one. And so, you are dealing with new form and obviously as a Company, I think we have taken a long-term view, which is why you see the engagement on the product.

It's working at scale. Content responsibility has been our most important focus for the past many years. And beyond that, I think we worked hard to make sure both creators can do well. It's a great platform for advertisers. We've had strengthened brand.

We built on it. We drove this momentum in direct response. There's obviously in a newer opportunity for just shopping which we are investing in. And [Indiscernible] represents an additional early but important area for us from an investment and growth standpoint.

So, I feel the fundamentals of the platform are strong. And with the long-term view, I see this is an area where we have more upside and so we will continue our investments with that in mind.


Thank you, and the next question comes from Colin Sebastian from Baird. Your line is now open.

Colin Sebastian

A couple of big picture questions. Sundar, first off looking at GCP and some of the innovations you've talked about, like distributed cloud, I just wonder what you think the long-term future is for hybrid cloud environments? Are they really -- or is this really just a part of the process or stepping stones to bring more companies, or most companies over to full cloud adoption? And then secondly, we're seeing a clear blurring of the lines among e-commerce, digital payments, and social platform.

So, I was hoping you could share the vision for Google and YouTube and the other Google apps in this context, how those pieces fit together, the closed loop, shopping platform, if that's the right way to think about it. Thank you.

Sundar Pichai
Chief Executive Officer

To your first question on GCP, part of our strength is we have taken a very open and scalable and flexible approach, and we don't view it as a one size fits all. So, we want to meet the customers the way they want to take this journey.