Google Inc.'s (NASDAQ:GOOG) position in mobile devices has soared in recent years as its Android platform has made gains in quality and availability. What does this mean for Google's bottom line? The purpose of this article is to describe both mobile platform competition (as opposed to hardware competition) and its significance for Google over the long term.
The mobile device industry is comprised of interlocking and interdependent vendors of mobile device hardware and mobile device platforms. This article examines Google's competitive position in platforms - the part of the product ecosystem that makes mobile device hardware work. The relative competitiveness of various platforms depends not only on the qualities of the software - which can change quickly, as evidenced by the development of various software marketed under the leading brands - but also on strategic factors such as how platform vendors profit from their platforms. A sister article will overview the market for mobile device hardware.
Google As A Platform Vendor
Google Inc. is the platform leader by unit sales volume. Google's business strategy in the mobile device market is an extension of its strategy on the desktop: it offers tools and technologies that make it easy for Google to reach customers served by its "real" mission. "Google's mission is to organize the world's information and make it universally accessible and useful." Google's business is selling advertisements, overwhelmingly for display to search customers, but also to viewers of static content and users of maps (which include paid vendors' locations on maps created for users looking for things nearby). Most of its revenues come from advertising displayed to users of Google's search tool.
Google only reaches customers who use Google to find data. To ensure access to customers, Google pays browser vendors for default placement in search windows by sharing search-driven revenue with users of the browsers' search function. Most of the funding received by the Mozilla Foundation comes from Google revenue splitting. But the benefit is both ways: Google only splits what it receives in revenues as a result of referred customers. Piper Jaffray estimated, for example, that 2% of Google's revenues came from customers using Apple's iOS platform. (Apple receives revenues for making Google the search default in Safari, but not the $1 billion reported in some places.)
Google's Android exists to ensure Google gets the first crack at mobile users' searches, and allows Google a chance to obtain those searches from Google-supplied applications on which Google keeps search revenues. Nevertheless, not all customers use search the same way: despite its enormous lead in Android over all other mobile platforms, Google actually derives more mobile revenue from Apple's iOS customers than from Android users. The fact that ad revenues aren't based solely on the size of an installed base, but are based on the conduct of users, is illustrated by another online ad vendor's claims that the iPhone 5 already eclipses Samsung Galaxy SIII's web traffic despite its recent launch and Apple's subsequent inability to satisfy demand. To succeed in revenue objectives, Google need not win in smartphone operating systems, provided it wins in user behavior. However, as mobile grows so too does the value of all those mobile users' searches. Android-driven search revenues have been growing with Android's installed base; although Google's mobile ad revenue is billions annually, Google's Android is a profitable but not presently dominant contributor to this mobile revenue.
A key factor to consider when thinking of Google as a platform vendor is that its revenues are not based on device sales, but on use by the installed base of mobile users. Unlike Microsoft (which obtains a one-time per-device license fee from OEM buyers of its mobile software) or Apple (which sells devices and profits from the entire hardware/software unit sale), Google's interest in users lies almost exclusively* with the mobile installed base and its users' decision to access Google, whether directly or through an application that accesses Google. Google need not win a sale to win a Google customer, but it understands how many users never change their default settings. (*: Google does sell some hardware, exposing Google to some time-of-sale revenues; but this is overwhelmingly through third parties including Android on devices from firms like Samsung, whose hardware sales dwarf Google's own.)
Giving away the operating system for free initially led to a variety of vendor-specific tweaks that made Android potentially unrecognizable from one phone to another. Freedom from Google oversight facilitated such variation that critics suggested different mobile carriers' Android installations weren't properly thought of as a single, unified platform. Google interceded with new rules governing how vendors would have to behave in order to access Google's application store, driving more uniformity and creating an application revenue stream to supplement its search revenue. It set standards for its application store, recognizing that a store full of malware would reflect badly on Google even if Google had nothing to do with the content in the store. Google effectively split the Android platform into two camps: one that would brand its devices Android and would access Google's store, and one that would be re-branded by third parties using Google's open-source code but might not have much connection to a broader Google-curated user experience.
Just because Amazon (NASDAQ:AMZN) and Barnes & Noble (BN) use Android code to power their e-readers doesn't mean that Google gets material revenue from their users. What Google gets by distributing open-source software is much closer to what Apple (NASDAQ:AAPL) gets from open-source software: more users who aren't locked into a Microsoft (NASDAQ:MSFT) platform dominated by Microsoft communication protocols driving users and their communications through Microsoft-designed interfaces and Microsoft-friendly vendors. For example, Apple released WebKit free to the world to combat Explorer-only web development - a task in which it has done an outstanding job. WebKit appears in Apple's desktop Safari, its mobile Safari, and in Google's Chrome browser (desktop and mobile both) and its ChromeOS (on which more later). Before Palm's acquisition by Hewlett Packard (NYSE:HPQ), it adopted WebKit. Nokia adopted WebKit for its S60. WebKit became the HTML rendering engine driving most of the mobile browsers on the planet, and helped drive Internet Explorer downward in share until in 2011 Explorer was no longer more popular than all other browsers combined. The result? New web sites must be coded to standards, because "Explorer-only" sites look broken to virtually all the mobile users and to half of all users. The wide deployment of open standards makes possible competition by both Apple and Google - and it didn't used to exist.
By offering a non-proprietary alternative platform, Google ensures that it has at least a fair shake in competing with other search and ad vendors for competitors. (Note that under the licenses governing Android, firms could use and modify the code without using the Android trademark or directing traffic to Google properties. People could just appropriate it. Amazon directs users to its own store for applications, for example.) There may be revenue in Android for Google, but that's not ultimately the point for Google any more than the iTunes Music Store was about revenue for Apple. The point was to make sure customers weren't all channeled somewhere else by a vendor who'd lock Apple out of competing for customers without paying steep licensing fees to do so. Android does this for Google. And like Apple's music store, Google's operating system earns the company profit along the way.
Google's Android platform allows Google access to revenue that isn't dependent on direct competitors like Apple and Microsoft, which have their own search systems, advertising platforms, and so forth. Android is a defensive play. Android does, however, lead to revenues - and the more attractive Google's mobile tools are to use, the more eyeballs its properties (and their advertisements) will get.
Google: Not Just The Platform
Google doesn't just license a free OS to hardware vendors. Google offers Nexus-branded hardware, and with its Motorola Mobility purchase has broadened its mobile activity as a hardware vendor. Since Google doesn't charge vendors for the Android platform, the tension involved in buying mission-critical IP from a direct competitor appears missing in Google's relations with hardware vendors such as Samsung and HTC. Compare this to Microsoft: after it announced it would ship its own Surface hardware, it began losing previously-announced hardware partners.
To recap the fallout of the Microsoft tablet hardware announcement: Toshiba simply retired. Texas Instruments (NYSE:TI), despite previously showcasing an omap 5 processor at CES and indicating possible 4Q2012 shipment of the processor - and being named a platform partner targeted with Microsoft's single-binary Windows RT release - gave up trying to replace Toshiba as a hardware partner. Shortly after Apple announced its A6 processor, TI announced it was shuttering its processor program targeting tablets and smartphones. (TI plans to focus on embedded applications, though Amazon and Barnes & Noble (BN) will still be able to buy parts for their existing tablets.) More recently, Asus announced that it would not have a Windows tablet on offer in 2012, but would release one after it had a chance to see Microsoft's surface launch. If Windows RT really costs $85 per license, how many vendors will over the long run choose to make tablets that compete directly with Microsoft's in-house Surface tablet as commoditization thins margins until scarcely any money remains after Microsoft's fees are paid?
Competing in hardware may not be a platform vendor's best chance to grow a given hardware/software ecosystem. Without multiple hardware vendors, limited sources of key platform components could stick a platform with persistent disadvantages. Both Microsoft and Google seem to pursue a strategy of profiting from units sold by third parties, so both seem set to benefit if their platforms are effectively evangelized by third parties who take on the risk (and cost) of developing and marketing salable units.
Some observers have concluded that Google's move into hardware was designed to enable it to show Android in a favorable light for thought leaders among developers and power users, rather than to replace ad revenue as Google's primary business. Whether hardware sales will be material to Google remains to be seen. As Microsoft did with its Xbox, Google has with its Nexus Q taken steps toward the living room and all the data consumption attendant users' audio and video appetites. And Google did buy Motorola, which we should expect to see producing Android mobile hardware. Since Google Play is experiencing rapid growth, we should not be surprised if Google ramps up media-center hardware that third parties are not currently supplying with Google operating systems. Efforts of this nature drift into the realm of hardware strategy, however, which is a topic for another article.
Google Doesn't Sell Products In A Vacuum
Google delivers virtually all its OEM Android installations in association with third party hardware vendors, with whom it has various relationships. Every installation is achieved against competition from other platforms - some sold by its own hardware partners. The financial incentives of hardware vendors and Google as a platform vendor are not cosmically protected from mis-alignment, and can generate competition even where it isn't obviously inevitable.
Understanding Google's position in the platform war requires comparison to its competitors. The second part of this article surveys Google's competitors (and what their circumstances mean for their long term role in the platform war). The competitive environment is the basis for conclusions about the future direction of Android's share among newly-sold smartphone units.
Google doesn't sell retail units (mostly), but derives its platform revenue from post-sale use. Google's enormous volumes make its per-unit costs trivial, which is advantageous because Google is giving away every unit for free in order to grow its share of the use-driven post-sales revenue, and to prevent the consumer market from being locked into platforms offered by vendors hostile to Google and its service offerings. Although Google's share in the mobile market is substantial, its revenues from the mobile market are both uncertain and much smaller than revenue Google obtains from PC-driven use. Android's dominance benefits Google partly by protecting its access to mobile users, and partly by increasing consumer awareness of Google and its brands so that people continue to think of Google when they want to find data on any platform. The next part of the article explains what Google's competitive environment means for Google's future as a platform vendor, and what Google's platforms mean for its OEM partners and its competitors.
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.