We Should Take Verstager Seriously But Not Panic

| About: Alphabet Inc. (GOOG)

Summary

The EU antitrust commission led by commissioner Verstager is going after Alphabet subsidiary Google again.

Google is giving away Android, but there are strings attached.

Verstager may actually have a case, and ultimately there could be consequences.

However, there is no need to panic, potential consequences are not entirely bad.

As Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) shareholders, we should seriously consider the possibility Google will at some point no longer be allowed to install Chrome or Google Search as defaults on Android phones.

Click to enlarge

Source: Wikipedia

EU commissioner Verstager may even have a point that it may not be entirely fair to force companies installing Android to choose between Google Play and Chrome or Android without Google Play. Specifically the commission believes Google violates antitrust rules by:

  • requiring manufacturers to pre-install Google Search and Google's Chrome browser and requiring them to set Google Search as the default search service on their devices, as a condition to license certain Google proprietary apps,

  • preventing manufacturers from selling smart mobile devices running on competing operating systems based on the Android open source code,

  • giving financial incentives to manufacturers and mobile network operators on the condition that they exclusively pre-install Google Search on their devices.

The commission also included a helpful graph:

googleEU.jpg

The media and commentators, myself included, have to be a little bit careful by copying words used by the commission as the wording used already frames the issue in a certain way. For example, the commission uses the words "conditions imposed," but these aren't actually imposed. They're merely conditions. Conditions on the use of a product are a widespread phenomenon. You can buy certain cats and dogs and not be allowed to breed them. "Payments not to install other search engines" is another way a business practice is framed to make it appear disingenuous.

This case matters more than the case Verstager initiated last year over Google Shopping, which received a lot of media attention. But just like last time, we shouldn't be overwhelmed with fear. Microsoft (NASDAQ:MSFT) went through a similar decoupling process after which consumers had to choose between a number of browsers:

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Source: Softpedia

Something like that could be a viable on Android systems as well.

Google's search, which is the company's cash flow generator, dominates Europe. Its browser (Chrome) doesn't come close to having anywhere near the same market share. Suggesting Google's search engine is the preferred choice almost irrespective of what browser or even OS the consumer is using. The competitive advantage Google's search engine holds over the competition, consisting of Bing and alternatives to search technology, widens every second the search engine holds a dominant market share. Analysts underestimate switching costs, as it is hard to judge how much search quality deteriorates when consumers switch from a technology that built up a vast high quality data head start.

Infographic: Google
You will find more statistics at Statista

There's not only a downside to this investigation either. It is questionable whether Google really needs to pay third parties to install its search engine as a default option. We have read reports Google pays Apple (NASDAQ:AAPL) a billion dollars per year (2014) to remain the default option on the Safari browser. Google could lose some market share and revenue due to the pressure from the Commission, but this will also reduce traffic acquisition costs or TAC. Incidentally, this may lead to wider margins on the remaining search business.

If Google doesn't manage to effectively ward off any penalties, I still consider it an overall negative. There could be a fine or settlement, likely much lower than the maximum fine you will see continuously employed in headlines, and it will hurt Google's ability to retain a de-facto monopoly in the European search market. In the short term, it could actually boost EBITDA if it means the company also gets rid of the TAC. It's worth paying attention to the case, but there is no need to panic.

Disclosure: I am/we are long GOOG.

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.