Contrary to custom, let us start this article with three questions:
- If Android phones outsell iPhones and Windows Phones, why do developers still prefer to write for Apple first? (maybe we should ask Seeking Alpha)
- Why does Android's higher unit sales provide no financial benefit to Google investors (as of yet)?
- Why did Google leave out international language support for Android regional builds? Why did Google try to fix internationalization half-heartedly in Android 4.1?
These questions are important if you are an investor in online smartphone-related businesses, whether in app developers or content providers like Facebook (NASDAQ:FB), or Google (NASDAQ:GOOG) itself. In the rest of this article, and possibly a future follow up, we will attempt to give our view of the answers, drawn from third-party research and our own proprietary and non-public models. Google's Android is the most popular smartphone mobile OS, but many are unaware of its monetization for Google. We will demonstrate why it cannot be half as good or as important as Google claims.
First, let us establish the facts. Google only makes money from Android when people use Google search and app services or when they buy apps from the Play store. What then if the user does not use these services? The other sources of revenue are ignorable. Here, we are ignoring devastating entrants like Amazon's Android, where Google's Play Store is left out altogether. Furthermore, many iOS users are using Google services, thus obscuring the claimed financial benefit from having Android. For instance, Google's Android Play Store is the only exclusive revenue that can be generated through mobile market share. Since Google does not break down Play Store revenue in its accounts, analysts had to reverse engineer it using Distimo third-party research. They uncovered earlier this year that:
Apple's App Store is generating $5.4m a day in app sales for the top 200 grossing iPhone and iPad apps. For Google Play, the estimate was just $679,000 for the 200 top-grossing apps on Google Play, or about 12% of Apple's revenue.
Clearly, as the above research illustrates, Android does not generate as much revenue from apps per handset as competing platforms. The lack of Play Store sales can be explained by the lack of cohesiveness within Android eco-system, and the targeting of the low cost sector. Google's CEO last year claimed: "Ultimately, application vendors are driven by volume, and volume is favored by the open approach Google is taking," said Schmidt, Google's CEO.
Shouldn't this revenue even if small per handset, more than offset the cost of developing and supporting Android? We will not pretend that we know the answers to those questions, which is why a market simulation was needed, however, the numbers on Google's accounts speak for themselves. It is nearly 2013, and a business like Seeking Alpha does not have an Android app yet, while the smaller installed base of iOS users already get a dedicated app. The answer might be found in the research by OpenSignals. They found 1,363 unique devices running Android, from 599 different brands. Even though Samsung dominates with about 40% of the market, developers get into trouble with users if they refuse to support other handsets. Success in the Play store, may require an app to work on at least 300 brands. Otherwise review scores significantly drop.
Lest you think Google needs Android to make money from mobile platforms, this little table should arrest your fears: look at the figure below, Google is in the top five Windows Store apps.
Furthermore, it must cross your mind that if Google can invest in search and provide meaningful revenue just by creating an app (cost base of effectively zero in comparison to revenue), why is Google in the business of Android? A business which generates no direct revenue outside of the Play store but lots of cost. With a 3:1 Android to iPhone sales ratio, how could the Play store revenue be 1/9 of Apple's App Store?
The usual Google answer that there will be additional ad revenue from Android just does not hold water. That revenue would have come from deals with other incumbent platforms (just like Google manages to compete on PCs without forcing users to choose a Google OS). Microsoft (NASDAQ:MSFT) in Windows Phone does a better job for developers by preventing fracture in the eco-system; they learned a great lesson from the older Windows Mobile platform. Windows Phone 8 provides a mix of the benefits of Apple (cohesiveness) and Android (dynamic and competitive). For Windows Phone there are only three major manufacturers, with only a handful of models each. The hardware is tightly controlled, unlike Android, while still being more flexible than Apple. These benefits together with international language support, which we discuss later, made us switch to WP8.
Google's Cost Base Rising Faster Than Revenue
Google, other than Play Store sales, has no direct financial monetization from Android, and this shows up in its relentlessly increasing cost base. Google's primary revenue is still search and related advertisements.
Source. We ignore the Motorola results for generating this chart.
Although Google is growing faster than Microsoft, its growth is slowing while Microsoft's growth in the Internet and Search business is at a steady average of over 10% year on year since 2010. Microsoft runs an old software house business model rapidly adapting to the new online world; so overall growth is muted. However, this pace can only accelerate with the help of mobile penetration and it may exceed Google over the next year. Microsoft's Windows Phone has a much stronger business case for its shareholders; in our client-focused market simulations, we could not come up with a scenario which warranted Google's investment in Android, other than if it replicates Apple's business model. Maybe that is the reason Google bought Motorola? Don't forget a large part of Android's rise is in cheap browser enabled smartphones. Those phones are really feature phones. Higher end Android phones, like the Samsung Galaxy S3, ship in a volume similar to Apple's iPhone 4s. Last quarter reports show 18m Galaxy S3s were sold versus 16.4m iPhone 4s's. Certainly not more than double the number of iOS numbers. It is the low-end phones that give Android 60% plus installed market share. Recent estimates show Android's share of new phones at just under 40% in 2012, compared to over 50% in 2011.
Google is losing mobile OS market share, while its current position has not resulted in the hoped for revenue. Let us delve a little deeper, into why it is losing market share with free Android, then we will look at why Google, unlike Samsung, does not make much money from the volume of Android handsets.
'Smart' Feature Phones Are Taking The Low End
Android, in the underpowered single core handsets, has taken a big share of the mobile phone market for casual internet browsers. Yet, it is also competing with the likes of Nokia's new Asha line. The low-end dominance explains why there is less internet browsing on Android according to metrics like netmarketshare.com. Otherwise, the net browsing market share is puzzling and troubling for Google, whose main monetary compensation for Android is via advertising and app sales.
By low-end Android, we mean, for example, the Samsung's Galaxy Ace and HTC Wildfire phones. Browsing with such phones is relatively slow and the devices are inexpensive. In fact, you might consider them high end "feature" phones. These users are liable to surf on their PCs and tablets, when given a chance. Low-end users do not help Android's net usage statistics, nor necessarily give Google any ad revenue advantage.
Microsoft is also entering this high-volume, low-margin business using Windows Phone 7, but it earns a license fee from every operating system sold; furthermore due to patents, it earns money even from Android handsets. In this market, Microsoft's business case is stronger. WP8 is radically different internally, being based on the NT kernel, while WP7 is running on Windows CE. The point for users is that WP7 apps run under WP8. WP7 is earmarked for the low end (e.g. Lumia 505), and the new WP8 is marketed for the mid- to high-end smartphones (Lumia 620, 820, 920). Plenty of people, including some professors at my university, are happy with basic phones; they see no need to check email and internet every second on their phones. These people now have switched to low-end Androids, but they use them much like simple GSM handsets. To be honest, I also miss the one week standby battery life of the simpler handsets such as the classical Nokia (NYSE:NOK) 1110. Unfortunately for me, the internet is important, so we cannot go back to those old phones. Investors must realize that this does not apply to everyone, and Google makes no benefit in being inside internet-disabled phones; losing such market share is not necessarily bad for investors.
There is a market for smart, user-friendly feature phones, and in that respect with Nokia, Google has a strong challenger. These newly-designed phones will likely cannibalize low-end Android handsets. If you want to invest in the "Wal-Mart" of smartphone manufacturers, we recommend both Nokia, and RIM (RIMM); they have the best value phones for the money. In the words of Nokia's Communication Director, who we recently spoke with, Nokia is still the world's largest "cheap" phone manufacturer. Nokia's Asha and RIM's lower-end BlackBerry bode badly for the future market share of Android.
Android's Lackluster Internationalization
The next reason Android is losing market share and internet browsing share, is related to the international language support. Android user numbers are peaking. We switched out of Android, because we needed a mobile operating system that works flawlessly in multiple languages. Google has never had proper support for right to left languages (RTL) like Arabic and Hebrew, in their LTR English builds. That is, not until Android 4.1 and still there are issues; see this for an example. If you have ever taken an English Android to Dubai and seen how the built in apps display RTL characters incorrectly, you will know what we are talking about. The programming resources and special builds are there, but since Android is free, Google was in no hurry to support RTL as well as LTR character formations, using unicode in a single build.
To our surprise and satisfaction, Windows Phone (8 and 7), just like iOS is international. You can install just about any language that is popular in the world using the same ROM build. There is no need to worry about buying a regional phone to have trouble free use of regional languages. This was the main advantage of iOS Vs. Android which has made iOS devices more popular than they might otherwise have been, in the non-European world. However, Windows Phone has some advantages over iOS, in particular, for mapping and security with exchange connectivity; that made it more attractive for our use case.
Google's Profit Is In Mobile Web Usage
If you are betting on Google Maps and location-based advertising as the future game changer for Google, think again. Google Maps is no longer the only free mapping solution. With Windows Phone 8, much like iOS, I was delighted to find Korean, Chinese, Arabic, Hebrew, Farsi, Turki, and Hindi and more languages - all supported in the same build. Furthermore, Nokia Maps and Nokia Drive, and HTC Locations with TomTom (for HTC phones) have fantastic support for downloadable international maps. These solutions require no data connection and support local languages fully, much more than Google Maps. Our Windows Phone, in Dubai, does not show garbage when RTL language text is sent, similar to our iOS-based iPad while all Androids less than certain revisions of 4.1 have this issue.
Looking at the IDC projections, with three-fourths of smartphones being sold having Android, investors have not yet internalized that Android's only profit for Google is increased web usage and app sales; Apple still leads in app sales as of today. Even the $25 developer fees for the Play store hardly covers Google's costs in maintaining the API and supporting developers; at 1 million developers, that is just $25million in Google's coffers. In fact, Google makes no money when Android users use text and telephony. Google makes money via search and via mobile app sales. These critical metrics are all extremely weak in the Android eco-system. It is clear that iOS and Android market share, in terms of handsets, is reversed when you look at web usage (see chart below); Apple dominates, while Android underperforms.
Furthermore, Comscore's latest research implies that nearly one in two people do not like browsing on their phone:
... barely half (50.2 percent) of U.S. mobile phone users launched an app during April 2012. Slightly fewer (49 percent) launched a browser. Some 36 percent checked in with social networks, while just under a third (33.1 percent) played games. (Source)
That, again, is not good for Google's business plan that only relies on ad share. Finally, from all this data, the not-so-obvious conclusion is that Microsoft, ultimately, will make more money from Windows Phone (WP) than Google will ever hope to make from Android. The more WP gains in market share, the more Bing becomes relevant in mobile search. While the reverse is not true. When Android rises, more likely than not those customers were already using Google, and thus provide little additional marginal revenue to Google. In that respect, Google's defense of Android makes no sense. In the meantime, WP8 will increase the usage of Bing search, and Bing Maps. Despite Google's Schmidt's claims since 2010 we think iOS, believe it or not, is more profitable for Google, based on the web usage results (See above). There are more iOS eyeballs using Google on their mobile devices than there are Android eyeballs. Which brings us back to the question: why was Android developed? Google is now in the handset business, and has set its executives as product directors on Motorola handset teams. This increases the chances of the likes of Sony (NYSE:SNE) and Samsung to consider jumping ship, or making tighter alliances with Microsoft in the near future. Even Facebook now makes more money from mobile than Google. If that does not worry Google investors, nothing can.
Tavis McCourt analyst's claim:
Apple is generating over 13 times Google's [monetization] in mobile, and in operating profits likely a similar multiple.
What is for sure, Apple and even Microsoft makes more from a registered user than Google. We put this down to temporary mismanagement.
If you own Google Vs. Microsoft, based on the mobile operating systems, we think you should take a closer look at your choice. Google is a faster growing business, heading for significant headwinds; Amazon rip-off of Android, fracturing of the ecosystem and lack of a proper business plan for Android. Meanwhile, Microsoft already dominates the living room with Xbox, has entered mobile strongly (WP8) and can only grow in internet ad revenue. We agree with the IDC projections, where Android is predicted to lose 10% share over the next 3 years. The loss of 10% share is not a disaster for Google, particularly as it does not derive much revenue from Android. However, a gain of 10% in mobile share for WP8 is a boon to Bing.
Furthermore, we like the segmented market approach that Microsoft is taking with Windows Phone, keeping apps compatible via virtual software technology implemented on two different operating systems (WP7 and WP8). Microsoft is our long term (24 Month) pick from these companies. As Nokia's partner, their Online Business Division will benefit in a variety of ways as mobile penetration of WP8 increases.
Please note that, we believe Microsoft may be one of the few tech companies you could buy and hold for the foreseeable future. Microsoft is not a value trap, like many "pros" believe, although it is very clumsy. That, however, will be a topic of another article. Overall, we like Microsoft, as it has its hands in all available pies, whether ARM (NASDAQ:ARMH) becomes dominant or Intel (NASDAQ:INTC), or online advertisement rises, or corporate IT budgets increase. Microsoft is a tech sector play, and probably one of the safest plays around. Google investors should realize they are now dealing with slower growth and higher risk in the form of large Android expenditure with no clear return and continued risks from absorbing Motorola's handset business.
Please note, at some point in the future we may be able to release the proprietary market simulation models which support our conclusion. Until then, we recommend you do your own independent research.
Disclosure: I am long MSFT, INTC, 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.
Additional disclosure: Please note that Apple is an altogether different case, as it is more a hardware company with software attached, so we intentionally left Apple out of focus. We may come back to Apple in a future article.
Disclaimer: We take no responsibility for any losses, nor do we take a cut from your gains if you follow any suggested actions. We highly recommend independent financial advice if you are not aware of the risks and psychology of investing in publicly-traded companies. As part of Technoor Consulting, we develop and simulate market forces using quantitative methods. We optimize our portfolio of stocks with such proprietary algorithms, not all of which I have permission to release to the public. If you like to know more about our market simulations do not hesitate to contact our company.