Each year, Alphabet Inc. the parent company of Google and several subsidiaries pays for the placement of Google as the default search engine in browsers. It records these payments under “traffic acquisition costs”, or TACs, in the income statement. Last year, Alphabet paid nearly $33 billion in TACs, and one company benefited greatly from these payments: Apple. Apple raised about $ 10 billion in TAC payments last year, according to estimates by Bernstein analyst Toni Sacconaghi. He expects the figure to rise to $15 billion this year, and it could reach $20 billion next year. He estimates that Google’s payments will account for approximately 9% of Apple’s gross profit in the 2021 fiscal year. Based on these facts, here are few questions you’ll agree investors need to ask.
What is the upper limit Alphabet can pay?
The reason why Alphabet continues to pay more money year after year is that the amount of search traffic and ad clicks on smartphones continues to grow tremendously. 68% of all search ad clicks occurred on smartphones in the second quarter, according to data from Merkle. That number was less than 60% two years ago, and less than 40% in 2016. Thanks to the standard search engine in Apple’s Safari mobile browser, Google gets an even higher share of ad clicks from smartphones – 71%. To top that, these clicks are increasingly valuable. Google’s search ad spend on smartphones continues to grow as desktop ad spend falls.
Given Apple’s dominant position in the smartphone industry – it has around 25% of the global installed base and more than half of the valuable US market – Google must ensure that it remains the default search engine on iOS. But it would not make sense for Google to pay more in TAC than it generates from search ads. This figure was estimated at $ 25 billion for 2020 in the middle of last year, and will probably be revised higher after Google’s performance in the second half of the year. Based on Google’s growth rate in 2021 and the continued shift to digital advertising and mobile, it could be close to $ 40 billion to $ 50 billion this year. As more advertising spend shifts to mobile, the number will continue to outpace Google’s overall revenue growth in search ads. It sets a pretty upper limit on Google’s willingness to pay. But at some point, Google will look to set a ceiling on its TAC with Apple, and growth will slow.
Will regulators have a problem with Google’s strategy?
Another reason Google continues to pay Apple year after year is to protect its position as the default search engine. Rival Microsoft also has deep pockets, and it can still spend quite a bit and make a deal with Apple profitable. There are also several smaller search engines seeking a place like Apple’s standard search engine. Regulators may view Google’s tactics as restrictive of competition. By paying into the likes of Apple’s pockets, Google prevents smaller competitors from having a chance to win.
With the increased control that regulators are giving large technology companies these days, the chances of a crash increase. And as payments increase, so do they. Sacconaghi said he believes any regulatory changes are still many years away, but they could have a negative impact of 4% to 5% on Apple’s gross profit if it is an unfavorable decision.
For Google, it is unclear how much damage it would cause if it could no longer guarantee the status of the default search engine. Many users are likely to change the standards to keep Google, but many more will not if Microsoft’s relative success on desktop devices is any indication. Bing has a market share of 12%, in line with Microsoft’s Edge browser market share.
Should Apple Create Its Own Search Engine?
Apple is currently collecting billions from Google just to change a few lines of code in the Safari browser. But if Apple developed or bought its own search engine and made it standard, it could potentially generate even more revenue than the billions that come from Google. It’s unlikely that Apple would be able to capture all of Google’s revenue opportunities on iOS. First and foremost, there will be users switching to Google products anyway. Take a moment to consider how many people download Google Maps and Gmail for iPhone instead of using Apple’s standard apps.
Secondly, Apple probably does not have the same revenue-generating capabilities as Google. Google has built an ecosystem of advertising tools for both supply and demand. It has millions of active advertisers already using these tools. And it has lots of user data it can use to ensure that the right ad appears in front of the right person at the right time. Google’s dominance across mobile and desktop computers ensures that it can re-target ads even when users switch devices. In short, a Google ad, even a search ad, is more valuable than an ad on most other platforms.
As long as Google continues to pay Apple more and more every year, the latter should probably be happy to collect the high-margin checks. But Apple should be ready to deploy its own solution if regulators crackdown on technology companies or Google reconsiders the strategy.