Last Friday, Jay Yarow at Business Insider reported the following tantalizing nugget:
“Apple made $1 billion off Google last year by having it as the default search engine in Safari, says Macquarie analyst Ben Schachter in a note this morning.”
Fascinating. But also not true.
I might just let this slide, except you can see how quickly this number has been spread around the Web in a few days, and has largely been accepted as a concrete fact.
I called Schachter on Monday to discuss the note that Yarow cites, and the analyst emphasized that the figures were rough guesses to make a larger point about the relationship between Apple and Google. More on that in a moment.
Indeed, even in his note, which was the source of the figure, Schachter writes of his calculations (and which Yarow cites but at the end of the post): “we acknowledge that this could be high.”
That thought struck me the first time I read the $1 billion figure. It just seemed too large. This figure quickly gained a lot of attention because the nature of Apple’s and Google’s relationship remains largely secret. Though it is of increasing interest. Indeed, on Tuesday, Bloomberg reported that the U.S. Federal Trade Commission had subpoenaed Apple as part of an anti-trust investigation of Google:
“The U.S. Federal Trade Commission subpoenaed Apple Inc. (AAPL) as part of its antitrust probe of Google Inc. (GOOG), seeking information on how the computer maker uses the search engine on the iPhone and iPad, two people familiar with the matter said.
The agency’s request for documents includes the agreements that made Google the preferred search engine on Apple’s mobile devices, said the people, who weren’t authorized to speak publicly and declined to be identified. Google rivals such as Microsoft Corp. (MSFT) have criticized these agreements as anticompetitive.”
Back to that figure. It does highlight some important issues that most average people probably don’t know. The main one being that Google gets some portion (we don’t know how much) of its traffic through exclusive distribution deals. In other words, it pays organizations like Mozilla or Apple to be the default search engine on their browsers. It also pays companies like MySpace and AOL for similar positions.
In his note, Schachter notes, correctly, that Google disclosed that it paid about $1.5 billion in 2011 on such distribution deals, something that appears in its annual report under the heading of “traffic acquisition costs.” But that is all Google will tell you about this topic.
Indeed, Google has fought the U.S. Securities and Exchange on disclosing more on this topic. Back in 2009, the SEC sent Google a series of letters asking why it didn’t break down the distribution number to let investors see how much it was paying each distribution partner. Google essentially said it wasn’t information investors needed:
“We believe that it is most appropriate to aggregate access points on a pooled basis for impairment testing. In any event, it would be unwieldy and ultimately highly inefficient to separately account for each of the over [CONFIDENTIAL** **CONFIDENTIAL] access points based on individual usage data.
But there are a couple of interesting things to note about that exchange. For instance, Google acknowledged that it does not necessarily make money on all these deals:
“We know that we will pay for many access points that will realize little or no revenue. At the time of entering into an agreement, we have no way of knowing which access points will realize revenue and which will not, but we must pay for all of them.”
There was some belief that Google was probably losing money on its MySpace deal. But then, in 2010, Google renewed the deal to the surprise of many. Why would Google keep paying for traffic in a deal where it was losing money? And indeed, why would it pay $300 million to Mozilla even though the share of its Firefox browser is in decline?
If one were cynical, one might suppose it is to keep the traffic out of the hands of competitors. And that may be exactly what the FTC is exploring.
Now, let’s go back to Schachter’s numbers. Schachter sent me a copy of his note. Of that $1.5 billion in distribution costs:
“For modelling purposes, we assume that Apple represented ~66% of this TAC (though we acknowledge that this could be high), or $1bn.
While I’m betting that Google pays Apple a lot, I still find it unlikely that it accounts for two-thirds of its $1.5 billion in distribution payments. The actual amount is something we just don’t know, nor do we know how many of these deals Google has.
But Schachter also assumes that Google is making $335 in net revenue on its partnership with Apple. I don’t think we can even assume that. After all, there were rumors that Apple might move to Bing, and you have to believe that Microsoft was putting in a competitive bid for that spot on Safari.
But Schachter’s next line is likely spot on:
“Notably, mobile/Apple revenue is among its fastest growing revenue drivers.”
And this goes the heart of the larger point of his note. At the moment, Google and Apple might be heated rivals. Who can forget Steve Jobs’ quote in his recent biography:
“I will spend my last dying breath if I need to, and I will spend every penny of Apple’s $40 billion in the bank, to right this wrong. I’m going to destroy Android, because it’s a stolen product. I’m willing to go thermonuclear war on this.”
Juicy, but for now, the companies also need each other. Apple needs Google’s search experience because it remains the best. Google needs the traffic it gets from Apple devices because they are growing so fast.
It’s worth noting, for those who have always been unclear about the importance of Android, why it’s so strategically important to Google. Just imagine if Apple had the same smartphone share as it did on tablets. Now think about how much more Google would have to pay for that search position. While Android doesn’t generate direct revenue, another way to think about its business value is that it saves Google hundreds of millions of dollars every year.
It’s also why Google desperately needs Android tablets to start making a dent in the iPad marketshare at some point. If Apple continues to dominate tablets, its leverage over Google will continue to grow in the coming years. Apple probably still can’t just dump Google, and it seems unlikely that Siri will be robust enough to challenge Google search any time soon.
Still, given the growing intensity of the rivalry between these two Silicon Valley superpowers, Schachter says that Google has to be concerned about either being cut off one day or forced to pay astronomical fees to maintain its search position on Apple’s tablets and smartphones as the balance of power tilts.
“They’ve become a bigger driver of traffic to Google,” Schachter said. “Apple doesn’t put Google there to help Google. They want to drive more usage of their phones and a better experience.
“The question going forward is: How much do you want to help your direct competitor?”