I think Satya Nadella put it pretty well in an interview: ad revenue, especially from search, is incremental to Microsoft; to Google, it's everything. So while Microsoft is willing to have worse margins on search ads in order to win marketshare from Google, Google has to defend all of their margins — or else they become significantly less profitable in their core business. LLMs cost a lot more than traditional search, and Google can't just drop-in replace its existing product lines with LLMs: that hikes their bottom line, literally. Microsoft is willing to swap out the existing Bing with the "new Bing" based on OpenAI's technology, because they make very little money comparatively on search, and winning marketshare will more than make up for having smaller margins on that marketshare. Google is, IMO, in between a rock and a hard place on this one: either they dramatically increase their cost of revenue to defend marketshare, or they risk losing marketshare to Microsoft in their core business.

Meanwhile, OpenAI gets paid by MS. Not that MS minds! They own a 49% stake in OpenAI, so what's good for OpenAI is what's good for MS.

If Google had decades to figure it out, I think your analysis might be right — although I'm not certain that it is, since I'm not certain that the calculus of "free product, for ad revenue" makes as much sense when the products are much more expensive to run than they were previously. But even if it's correct in the long run, if Google starts slipping now it turns into a death spiral: their share prices slip, meaning the cost of compensation for key employees goes up, meaning they lose critical people (or cut even further into their bottom line, hurting their shares more, until they're forced to make staffing cuts), and they fall even further behind. Just as Google once ate Yahoo! via PageRank, it could get eaten by a disruptive technology like LLMs in the future.