GOOGL: It’s not About the Hardware

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Artur Pylak


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October 4, 2016

GOOGL: It’s not About the Hardware

While GOOGL’s “Made by Google” presentation purported to emphasize the company’s increasing emphasis on its eponymous hardware, it was really about the increasingly powerful AI-fueled Google Assistant and a plan to make it a ubiquitous interface across more than just its own devices. The Pixel phones were attractive and impressive, but no more so than recent offerings from AAPL and Samsung. Smartphone hardware specs are now at a point of significantly diminished returns, with all flagship models sporting similar processing power, screen resolution, and camera quality. The real purpose of Pixel, and the also announced Google Home connected speaker, is as clean canvases for Assistant and its underlying services, showcasing it as a more capable and better integrated assistant than AAPL’s Siri, MSFT’s Cortana or AMZN’s Alexa. We believe Assistant is positioned to deliver capabilities that none of its rivals can easily match, tapping the depths of GOOGL’s vast knowledge graph and its extensive understanding of its users interests and behavior. It can front that knowledge advantage with best-in-class natural language processing, predictive analytics, and image recognition derived from its leadership in deep learning. It backs it with an ability to reach consumers across applications and across platforms, including those controlled by others. We believe that Assistant will extend its advantages over time, driving share gains for Android devices and cementing the primacy of GOOGL apps across all platforms.

  • Cool phones – who cares? The Pixels are solid phones featuring all the must have flagship phone specs: top of the line QCOM Snapdragon 821 SoC, AMOLED display, 12.3MP camera with 4K video capabilities, 18W fast charging, USB-C, 4GB RAM, 32GB or 128GB internal memory, etc. Management claimed leadership, but these features aren’t radically differentiated from the tech specs of Apple’s iPhone 7 or Samsung’s Galaxy S7. Smartphone innovation has turned incremental, with no major hardware breakthroughs in the past few years. The Pixels, and the Google Home connected speaker, are just platforms for GOOGL to show off its AI chops.
  • GOOGL is the dominant force in commercial AI. While the building blocks of deep learning systems are simple, the most powerful models are anything but. With thousands of building block algorithms combined by feedback loops into multiple layers designed to learn as they iterate through huge collections of data, outstanding AI solutions must be carefully built and adjusted for optimal results. This takes experienced talent, big data and powerful processing platforms. GOOGL exceeds at all of these. It is the largest employer of AI talent with nearly 25% of the world’s leading AI scientists working in the private sector, has one of the largest consumer datasets, and controls the largest and fastest hyperscale computing platform on the planet.
  • GOOGL is exploiting its AI advantage. GOOGL’s AI assistant has become much more powerful in recent years. During the keynote, GOOGL CEO Sundar Pichai touted advancements in Google’s knowledge graph, natural language processing, translation, voice recognition, and image recognition. Recently, we looked at digital assistants in depth: GOOGL is uniquely strong across all AI and non-AI ingredients necessary for winning the virtual assistant race, with a combination of cutting edge technical excellence, massive data assets, and long reach through its dominant applications and leading Android platform. We believe that AI will soon drive a revolution in the way users interact with devices and cloud-based services, obviating the app-based GUI that has been, thus far, the hallmark of the mobile era.
  • A very personal assistant. Pichai noted GOOGL’s goal is to “build a personal Google for each and every user.” This can only be made possible with best in class AI software that can accurately interpret queries – spoken and written commands, even gestures and facial expressions – and intuit unexpressed needs – based on context and data rich user profiles – to answer questions and fulfill service requirements with increasing expediency and effectiveness. Google Assistant already goes well beyond the capabilities of Siri or Alexa, in its ability to interpret human language, predict needs, intervene in many ways, and link directly into apps to find information or execute a task
  • An omnipresent assistant. Google Home is a very similar to the Amazon Echo, but much more capable given the strength of Assistant’s language comprehension, its integration with GOOGL’s services and its compatibility with other devices. This device extends the power of Google Assistant from the smartphone GUI throughout the home, maintaining the continuity and personalization of services like search or YouTube in all contexts. Beyond playing media on request, answering questions and executing tasks on Android apps, Google Home can be integrated with several IoT standards to control other devices, such as Nest Thermostats, Philips smart lighting fixtures, and Samsung Smarthings sensors. With the reach of the Android ecosystem, we expect Home to go beyond Alexa in adding partners for its smart home offerings.
  • From a mobile/app to an AI paradigm. The rise of virtual assistants reverses the mobile era trend toward independent apps, which had begun to blunt the strength of GOOGL’s search franchise. Users will now access the services and information provided by apps through the single Assistant interface, entering individual apps only as required. GOOGL’s towering strength in AI, combined with its dominant Android platform, billion+ user reach, powerful app franchises, and vast data resources, make it uniquely well positioned to win the virtual assistant race. Moreover, GOOGL will release an SDK for Assistant later this year, and we expect it will be available on all platforms, giving it an advantage over AAPL and AMZN, which tightly control their AI Assistants within their ecosystems of products.
  • Bad news for apps. Consumers already use few apps regularly with 49% using 6 to 10 apps in a given week. Only the most differentiated can survive. AMZN and FB are powerful enough to resist deep linking, and can maintain their strong, independent engagement on their rival’s platforms despite the paradigm shift to AI assistants, even if their dreams of gaining primacy are unrealistic. However, less frequently used apps with more questionable user loyalty face an existential threat, as enabling deep linking erodes differentiation, while blocking it invites irrelevance.

The Dog and Pony Show

GOOGL borrowed a page from the Apple playbook during its “Made by Google” product keynote earlier today, unveiling a parade of hardware products aiming for ubiquity at home and on the go. But the presentation wasn’t really about the slick hardware. The real purpose of Pixel, and the also announced Google Home connected speaker, is as clean canvases for GOOGL’s AI driven services, notably “Google Assistant,” showcasing it as a more capable and better integrated assistant than AAPL’s Siri, MSFT’s Cortana or AMZN’s Alexa. We believe that these services will replace the mobile app user interface paradigm with a greatly enhanced search-like facility that intuits meaning to user queries and reaches into apps and web sites to answer questions and perform requested tasks directly. Spoken commands, text entries, and clicks, will be enhanced by gesture controls, eye tracking and facial expression analysis, and user needs will be inferred by context and previous experience to provide timely information and services without explicit queries.

Taking to the stage in the old Ghirardelli factory building in San Francisco, GOOGL CEO Sundar Pichai emphasized the company’s plans to “build a personal Google for each and every user.” He opened the keynote with some impressive stats on the company’s quickly evolving AI capabilities. Google’s key dataset, its “Knowledge Graph” contains some 70B facts. Image captioning and tagging has become more accurate at 93.9% versus 89.6% just 2 years ago, while it also increased the level of detail the AI can discern from images. Language processing and translation has also improved, with Pichai emphasizing the company’s advances in getting to an AI that can better understand languages and accents, as well as sound natural when producing synthetic voice interface. These advances are not surprising given the company boasts the largest and most deeply qualified pool of AI talent in the world employing a quarter of the most highly cited AI scientists working in the private sector, has the largest barometer of consumer intentions in the world via its dataset, and has the largest and fastest hyperscale datacenter infrastructure in the world (Exhibit 1).

The Pixel phones and Google Home speaker unveiled by GOOGL’s newly rebooted hardware division are essentially meant to showcase the capabilities of the AI and likely work as reference designs/benchmarks for the company’s vast ecosystem of hardware partners. We don’t expect the Pixel phones to displace either the iPhone or Samsung’s Galaxy line of smartphones as the best-selling handsets in the world given the hardware specs are fairly standard of a flagship phone featuring only incremental advances in capabilities and a limited distribution plan (Exhibit 2). On the other hand, the Google Home speaker, priced $50 less than AMZN’s Echo, is meant to be that device that consumers didn’t think they needed. With an attractive price point, better underlying AI, and a larger ecosystem of partners, Home is poised to do well against the Echo. The other products: which include updated Chromecast, Daydream VR headset, and Google WiFi are merely accessories. Though Chromecast has sold over 30M units, going 4K is addressing a subset of TV owners. The Daydream VR is simply an accessory building on “Cardboard” to make simple VR content such as 3D/360 photos easier to comfortably view. It is not real VR in the same vain as FB’s Oculus. We expect GOOGL to return its focus to Augmented Reality as its computer vision capabilities improve. The Wifi product is merely meant to facilitate better connections to ensure the AI can be ubiquitous throughout a home.

As we detailed in our AI Assistants note (, the downsides of the app model are becoming more apparent as app fatigue sets in. AI virtual assistants will change things (Exhibit 3). 90% of usage is concentrated in a user’s top 6 apps, while 9 of 10 apps that are downloaded are used no more than once before being relegated to the scrap heap. Most users do not download even a single new app in a given month. In 2015, Google introduced deep linking, which enables Search and Google Now to reach inside of apps to find pieces of information and service functionality of interest to users. During today’s keynote, a GOOGL exec demonstrated just how seamlessly Google Assistant works with features of specific apps. For apps long ago banished from the home screen to the app drawer, this could be new life, but to the icons enshrined on page one, it is a threat. This year, it announced Android Instant Apps, which allows it to grab content from apps that have not even been installed and temporarily run the just portion of the app necessary to show the information or provide the service requested. Now layer in Assistant as the primary interface to the device – request a service and Google can find the best solution based on the user’s stated preferences and demonstrated needs, whether or not the user had even downloaded the app to their smartphone. AI threatens the existing app model, but we expect the strongest and most used like FB, AMZN, and NFLX to do well, while companies like PCLN, EXPE, TRIP, GRUB, YELP, YHOO, EBAY, and others who have benefited from the app model and could see significant competition enabled by the rise of AI virtual assistants.

Exh 1: AI Scientists and Citations by Company, September 2016

Exh 2: Profiles of Flagship Smartphone Offerings, 2H 2016

Exh 3: Roles of Deep Learning Positioning Among Major Virtual Assistants

Exh 4: The SSR AI Heatmap

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