google paying to Apple for search engine on iOS devices

Apple Inc. (NASDAQ:AAPL) and Google are two of the most recognizable names in the tech industry. Both companies were responsible for pioneering the smartphone revolution nearly a decade ago that now engulfs the entire world. Google is the gateway to the modern internet, while Apple moulded the smartphone into what it is today. Billions of people across the globe have invested in the products and services provided by these mega-corporations, and use them on a daily basis. Naturally, there is a strong rivalry between the two companies, as well as their loyal users. Google and Apple both routinely compete in the smartphone software and hardware space. Recently, Apple has also been expanding their services business which has begun to encroach on Google’s territory. With all this in mind, it is quite surprising to learn that Google may pay up to $3 billion dollars to Apple.

So, why is Google paying such a massive amount to their direct rivals? What is the thought process behind this, and who is this deal more beneficial to? Let us have a look.

Why Is Google Paying Apple Monstrous Sums Of Money?

According to reports, Google may have to pay up to $3 Billion in FY 2017 to remain the default search engine on Apple iOS devices. This represents a 300% increase over the $1 billion dollars Google paid Apple in 2014 for the same purpose. This would represent as much as 5% of Apple’s total operating profit in 2017 and nearly 25% of their total operating profit growth over the last two years. On the surface, it makes sense that Google would want to retain their default presence on Apple devices. Apple’s devices are some of the most popular smartphones in the world and account for considerable market share. Google’s presence on Apple’s platform ensures access to the large and varied user base that contributes greatly to their increasingly mobile first ad revenue model.

However, the question is – Why has the licensing fee tripled in just three years? According to the estimates, the licensing fee is based on a percentage of the revenue that Google generates from Apple users. Google’s total mobile ad revenues more than tripled from $16 billion in 2014 to $50 billion in 2017. Therefore, it stands to reason that Apple’s share would also triple from $1 billion to $3 billion.

Who Stands To Gain More From This Deal?

At first glance, this deal seems like an extremely lucrative proposition for Apple. The entire sum of $3 billion directly translates to profits for Apple, with negligible operating costs. It also provides a boost to their burgeoning service business. We recently reported on Apple’s increasing focus on their services business, which may overtake their hardware division in terms of revenue in the coming years. As it stands, services already contribute around 16% to Apple’s overall revenue. Licensing fee from Google makes up a huge chunk of that share. We can clearly see that this deal directly benefits Apple and furthers their agenda for their services business.

However, this deal is also very important from Google’s viewpoint. Ad revenue is central to Google’s financial model and has been for years. The growing importance of the mobile internet has now shifted the ad revenue playground from desktop to mobile devices. In fact, Google is expected to generate nearly $50 billion in revenue from mobile ads in CY 2017.

Maintaining a hold on mobile is crucial, especially in light of ever increasing competition from the likes of Facebook. The importance of Apple’s ecosystem for Google becomes apparent when you consider the fact that iOS devices contribute 50% to Google’s overall mobile search revenue! This clearly demonstrates Google’s need for unfettered access to Apple’s user base in order to continue raking in massive amounts of ad revenue.

Of course, it’s not like Google can’t afford it. Google’s net global revenue in 2016 was just shy of $90 billion dollars. Taking that into account, $3 billion is a small price to pay to get access to a vast and valuable advertising audience.

The Apple-Google Deal’s Days May Be Numbered

While this licensing deal between Apple and Google is a mutually beneficial proposition for both parties right now, that may soon change. Since the fee is based on a percentage of Google’s net ad revenue from Apple users, it could keep rising indefinitely as Google’s revenue share grows. At some point, Google may be unwilling to pay Apple the ever increasing and inflated fees. In such a situation, if Google is confident of retaining a majority of their customer base despite not being the default search engine on Apple devices, they may decide to terminate their licensing deal with Apple. This would undoubtedly put a huge dent in Apple’s service business revenue and affect their profits. Such a decision could potentially also backfire for Google. They would risk losing a large install base who may be tapped up by rivals such as Facebook, Amazon etc.

According to some estimates, if Google can retain 80% of their iOS search volume, then it would be financially more viable for them to break off this deal with Apple.