The European Union recently slammed Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google with a $5 billion antitrust fine over its bundling of first-party software services into Android, the most widely used mobile OS in the world. The EU claims that Google pressured smartphone makers to pre-install apps like Search, Chrome, and the Play Store.
The EU also claims that Google actively prevented OEMs from selling phones running on "forked", or modified, versions of Android which didn't come with pre-installed Google apps. The European Commission is giving Google 90 days to halt those practices, or face additional fines of up to 5% of Alphabet's average daily worldwide revenues.
The Commission states that "at a minimum" Google must stop bundling its search and browser apps with Android, halt "illegal" payments for the pre-installation of Google Search on devices, and stop obstructing the development and distribution of competing versions of Android. Google said that it would appeal the decision.
This isn't the first time the EU fined Google. Last year, it levied a $2.7 billion fine on Google for favoring its own shopping service over those of other retailers in its search results. Let's see how this new fine could hurt Google's mobile business.
Understanding the battle over Android
Android is an open source operating system, which means that anyone can modify the source code. Apple's (NASDAQ:AAPL) iOS, for comparison, is a closed source OS. Android was created by Android Inc., a start-up which Google acquired for at least $50 million in 2005.
Google developed Android as an operating system for mobile devices, which piqued the interest of handset makers. After Apple launched the first iPhone in 2007, those OEMs rushed to license Android for their touchscreen smartphones.
Google didn't charge OEMs to license Android. Instead, it gave it out for free with core Google apps bundled into the OS. Those apps were big selling points for the devices, which were often dubbed "Google Phones". Most OEMs modified certain aesthetic aspects of Android, but happily retained all of Google's core services.
Over time, Google Android became the dominant version of Android. The only "forked" version of Android that flourished was Amazon's FireOS, which powers its Kindle and Fire TV devices. Other hopefuls, like Cyanogen, fizzled out as consumers shunned the idea of a Google-free Android. Most Android phones in China run Google-free versions of Android, but only because its Search and Play Store are banned in the country.
Google added an increasing number of first-party apps and services to Android in recent years. Critics claimed those were anti-competitive moves, since they hurt competing services from rivals like Microsoft (NASDAQ:MSFT). Yet those bundles became Google's core mobile strategy, since they kept users locked into Google's services, gathered data for targeted ads across multiple platforms, and generated revenues from mobile searches and Play store purchases. Mobile ad revenues now account for over half of Google's total digital ad revenues.
What's Google's next move?
Therefore, the real pain from the EU ruling won't come from the $5 billion fine, which will be written off as a one-time charge like its $2.7 billion fine last year. Instead, the pain will come from the derailment of the company's mobile strategy in Europe -- which could set a precedent for similar antitrust rulings in other markets.
To make matters worse, the EU is still running a third antitrust probe against Google regarding its search advertising service AdSense. A third of Google's revenues came from the EMEA (Europe, Middle East, and Africa) region last year, so there's a lot at stake if the EU lands all three blows.
Google CEO Sundar Pichai warns that the EU decision will "will upset the careful balance that we have struck with Android," and that it could need to charge OEMs to license Android to offset its lost mobile revenues. However, Google could struggle to pull that off without sparking more litigation, since most Android OEMs are already struggling with low margins in a saturated market.
Many Android users will likely install Google's services on their new phones if they aren't pre-installed, so the existential threat of the EU decision is probably overblown. However, the ruling could leave Google more vulnerable to Microsoft, which previously signed deals with leading Android OEMs like Samsung to pre-install its competing apps on their smartphones.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Leo Sun owns shares of Amazon and Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.