Google parent Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG) recently announced its plan to comply -- while its appeal is pending -- with the European Union (EU) Commission's ruling handed down over the summer of 2018. The commission's decision, which was accompanied by a $5 billion fine, is meant to increase competition and the choice consumers have when using their mobile devices. While Google is appealing the fine and ruling, it has revealed how it plans to comply in the interim by making changes to its Android platform for mobile. The result could mean Google's business gets even stronger.
The EU's beef with Android
Google's Android is an open-source operating system (OS) for smartphones, tablets, and other mobile devices -- meaning hardware manufacturers are free to alter the software to fit their needs. Manufacturers who make extensive changes to Android sell what are known as "forked" devices. The most common of these are Amazon's (NASDAQ:AMZN) Fire devices, which come with their own set of Amazon apps and services pre-loaded.
For manufacturers that wanted the convenience of the OS plus a suite of software and services to go with it, Google offered an Android license for free. However, the Google Play Store for app downloads was required to be bundled with Google Search and Chrome internet browser, and manufacturers had to pre-install numerous other Google apps and search products on devices. Google was able to license its OS for free because it makes the lion's share of its revenue off advertising on Search -- to the tune of 86% of the company's $32.5 billion in revenue last quarter.
The EU Commission ruled that Google's requirements for a "free" license -- plus incentive payments to some manufacturers based on ad revenues generated (like what Alphabet pays to Apple, for example) -- restricts consumer choice and stifles innovation. Indeed, Android commands a near 90% market share of mobile devices; hence the record-setting $5 billion fine and order to change Android's business structure.
The "new" Android for Europe
Google contends that its platform hasn't limited choice or squashed innovation; on the contrary, the company asserts that its free sandbox (paid for by advertising) allows device makers and software developers a rock-solid and always-improving platform on which to build. Its app store is the largest in existence, boasting millions of third-party offerings, and consumers are free to download a different suite of services if they don't want to use Google Search.
Nevertheless, Google has a plan to comply with the EU ruling: It will allow the creation of "forked" devices in the EU that make use of the Play app store separate from Search and Chrome. A separate licensing agreement for Search and Chrome will continue to be offered as well.
But here's the catch: Since Android was developed as a free, open-source OS contingent on the use of Google Search, developers wishing to make "forked" devices that include the Play store will now have to pay a licensing fee to exclude Search and Chrome as the primary options pre-loaded on the device.
Google is hard to break up with
According to a report from The Verge, that licensing fee will be as much as $40 per phone and $20 per tablet. The fee could be waived with the additional licensing of Search and Chrome.
This report is not official, but if Android starts carrying a licensing fee if Google Search services are rejected, there's a chance this will open up an entirely new regulatory can of worms. Nevertheless, Android license fees from the EU could bring in significant revenues. Smartphone shipments alone in the region easily surpass 100 million a year. Android licensing revenue could thus become a multibillion-dollar sales source for Google overnight.
With so much of Alphabet's empire riding on advertising, software licensing has become a key area of growth and diversification. The EU, at the very least, may have made it easy for Google to test out a new software business segment in a key market. Plus, a device without Search pre-installed doesn't mean the consumer can't make use of Google anyway. Developing a suite of robust software as Google has isn't easy, and many device manufacturers are cash-constrained as it is. So, licensing fees plus continuing advertising revenues? That possibility is certainly in the cards.
Put simply, it's understandable that the EU wants to foster choice, competition, and innovation. But the Commission may have just ventured into the realm of unintended consequences. Google will not only survive, it could come away stronger than ever in the end.
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. Nicholas Rossolillo and his clients own shares of Alphabet (C shares) 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.