Editor’s note: Alphabet’s (Google) 1Q16 performance highlights its ability to continue to experiment with “other bets” while Google’s advertising continues to drive, says analyst Daniel Callahan of Technology Business Research.

HAMPTON, N.H. – Alphabet’s 17% year-to-year revenue growth in 1Q16 to $20.3 billion illustrates that Google’s transition to Alphabet hasn’t snagged the company’s growth potential. Google’s revenues climbed 17% year-to-year to $20.1 billion in revenue in 1Q16, led by a 20% increase in Google websites revenue in the same period, demonstrating that adjustments to its search algorithm to be more mobile friendly, in addition to improvements to programs such as TrueView and Google preferred are driving revenue. While less of an impact than Google’s advertising business, Google’s other revenues grew 24% year-to-year to $2 billion indicating that Google’s Play media and app purchases are continuing to drive revenue, and Google for Work and its cloud storage offerings are gaining traction.

In addition to strong revenue growth, Alphabet’s gross margin also remained historically average in the low 60s at 61.9%. However, it did decline 130 basis points year to year due to a 20.3% year-to-year increase in 1Q16. While some the expanding cost of revenue are stemming from Google, including an 18.9% year-to-year growth in traffic acquisition costs. Despite a slight decline in gross margin, Google will continue to benefit from the still lucrative advertising business from Google.

Alphabet’s combined operating margin ended at 25.8% in 1Q16 – about average for Google historically. Google’s operating margin was a strong 31% in 1Q16, it benefitting from being unchained from the experimental other bets which haven’t yet all proved profitability or are in experimental stages. Despite a smaller base, Other bets had a negative operating margin of 483% in 1Q16 proving the difference in costs and profitability between Google’s advertising business and side businesses.

Google will continue investments in side businesses, strategic hiring and capex expenditures to position itself in growing markets. It will also focus on improving its advertising business which will, for all purposes, continue to bankroll its other bets while they seek profitable business structures.

Google Fiber makes changes to its services and products promote profitability and competitiveness

Google Fiber gained more independence as separate business, after Google’s reorganization in August 2015, under new Alphabet subsidiary “Access” headed by CEO Craig Barret. However, Access, and Fiber within it, is no longer able to rely directly on advertising revenue from when it was under Google’s umbrella to support Fiber’s incubation. In order to promote profitability and revenue growth Google Fiber has undergone service and product changes to meet revenue goals in 1Q16.

Previously in Kansas City, its inaugural city, Fiber allowed users free-of-cost 5Mbps internet with a $300 installation fee. However, this low tier service, which TBR believes was used to drive hype around Google Fiber in its early stages, was transformed into the Fiber 100 plan which now costs $50 per month for unlimited data use at 100Mbps upload and downloads speeds and no installation fee with a 12 month contract. Google’s mid-tier plan is now named Fiber 1000, and has remained effectively unchanged at $70 per month with 1000 Mbps upload and download speeds and 1TB of Google Drive storage. Finally, there is the Fiber 1000 + TV for $130, which includes everything from the mid-tier Fiber 1000 plus over 150 channels and DVR capabilities.

TBR believes Google Fiber’s ultimate goal, before its separation from Google, was to foster development of the broadband ecosystem so it can indirectly drive revenue of Google’s core online advertising business. However, TBR asserts, as Fiber settles into an independent existence, it’s also to bolster its business model. These service changes allow Google Fiber to offer more pricing options to customers and better sustain and position itself as an independent revenue driving business.

In addition, Google Fiber, in an effort to better compete against traditional telecom providers, is slowly rolling out triple-play capabilities with an added VoIP-based landline phone service to its internet and TV offerings. This service will cost an additional $10 per month which includes unlimited local and nationwide calling and users will be able to transfer existing numbers to the service. TBR believes this service is further evidence of Google Fiber’s ambitions to move beyond just a broadband pipe provider and into a more competitive position against telecom and cable incumbents who remain tethered to the traditional model of networking.

This service, which costs less than half the average incumbent landline phone plan, will make Fiber more attractive to switchers attached to legacy features such as phone lines. Also, in an effort to surpass traditional landlines, the service borrows ideas from Google Fi including being able to make calls from any mobile device or PC and transcribed messages sent to email or text. In the future, Google will likely bring closer, if not outright tie together, its Fiber Phone service and it’s Project Fi, which would not be extraneous due to their shared heritage on the Google Voice platform. One platform for both services would assure optimized user experience and seamless transitions.

Despite its transformation into a stronger competitor to the orthodox telecom provider, Google Fiber is still struggling with the expansion of its service into areas where adding optical fiber isn’t fiscally sound for the company. Google Fiber has been experimenting with a wireless and fiber hybrid service to extend Fiber services to areas where traditional expansion isn’t fiscal. It is unknown exactly what, beyond connecting Fiber optic lines to wireless towers equipped with unspecified wireless equipment, the service will entail. However, Access CEO Craig Barret emphasizes that he sees it as a strong business the company will pursue.

(C) TBR