Rumors abound when it comes to Apple (The AAPL -2.03%) and new technological equipment. Remember the Apple TV (Apple of course offers many services for television)? Rumors (or maybe hopes) are still swirling about a possible Apple Car, and there are persistent rumors that an Apple AR/VR headset is in the works.
But it’s not just hardware. There’s also lingering speculation that Apple is also building its own internet search service. That would be bad news for Alphabet (GOOGL -1.84%) (GOOG -1.79%) and his primary breadwinner, Google. But would Apple really pull such a move and cut Google out of the mix in its lucrative hardware empire?
An incredible hardware company with unprecedented power
First, a quick introduction. To date, Apple’s empire is primarily based on hardware sales – and it’s done a great job of attracting consumers to its ecosystem (which includes Macs, iPhones, iPads, Watches, etc.) and keeping them there. This is a classic expansion strategy: once a sale is registered (an iPhone, for example), Apple can then push other types of devices by touting how tightly integrated they are.
– Advertising –
But the device-centric business model has slowly changed over the years. Software and other revenue not related to a sale of computing devices – the Services segment – generated revenue of $19.6 billion in Apple’s Q3 fiscal 2022 (which ended June 25). This was a 12% increase over the previous year and accounted for nearly 24% of total revenue, making Services Apple’s fastest growing segment.
The alphabet comes on the other side of the equation. It is a software company and monetizes primarily through advertising. It slowly got into the hardware game, but ads are still the main driver of its internet business. Accessing Apple’s global installed base of devices currently in use (with 2 billion active devices, the majority of them iPhones) is a big problem for Google. It would shell out billions to be the default search engine on Apple devices.
Neither Apple nor Google actually discloses what Google pays Apple for Internet search privileges. But estimates point to $15 billion in 2021, rising to a range of $18-20 billion in 2022.
In other words, a significant growth in Apple Services (and a significant portion of this revenue segment as a whole) comes from Internet advertising.
Since Apple tightly controls its ecosystem of devices, why not just use those hefty payments from Google to build its own search engine and eventually ditch Google altogether? It might make sense one day. After all, Google’s advertising business generates pretty healthy profits, even after the significant traffic acquisition costs (TACs) paid to Apple. In the second quarter of 2022 alone, Google’s own services segment (mostly advertising) generated operating income of $22.8 billion, or a profit margin of 36%.
Incidentally, Alphabet’s TAC payments are where Apple’s royalty estimates come from in the first place. Alphabet says Google’s TAC topped $24 billion in the first half of 2022. While Apple’s mobile operating system accounts for just over half of the US market share and nearly 30% worldwide (Alphabet’s Android making up the balance), estimates imply that around 40% of that TAC (or between $18 billion and $20 billion) goes to Apple each year.
Is Apple already laying the groundwork for a search engine?
Apple could already be testing the waters for a rival internet search engine. After all, there’s already antitrust regulatory scrutiny on Apple accepting payment from Google in the first place. But on top of that, Apple has already monetized search through ads for years in its App Store. Software developers can pay Apple to promote their app to reach more Apple users.
But there’s also Apple’s new Activity Tracking Transparency (ATT) feature (it’s a prompt that Apple sends you asking if you want to sign up for a usage activity tracking app of your device). Apple touted this feature as proof of how much it cares about your privacy. But many developers and marketers say Apple uses ATT to limit outside companies’ access to user data and promote its own advertising channels (which have access to user data) within its massive device base. . Given that device sales as a whole have slowed down over the years, and given Apple’s growing focus on services, building its own advertising empire makes financial sense.
In fact, reports suggest that Apple is aggressively increasing hiring for its own internal advertising segment. Apple’s ads segment could already redirect billions of dollars a year in targeted advertising internally with the help of ATT, while making it harder for Google. Meta-platforms (i.e. Facebook), and others to sell highly profitable targeted ads. If the claims are true, Apple is undermining the ability of other marketers to sell ads to iPhones and the like while simultaneously promoting its own targeted advertising channels.
What is the connection with the development of an Apple Internet search engine? The creation of an advertising company – the main way to monetize Internet search, at least today – could be the eventual precursor to Apple going head-to-head with Google. However, cataloging the Internet itself is a huge task that requires the ability to collect and process a bewildering amount of data. Google has about 20 data centers around the world and leases far more space for its servers in third-party data centers. Even for Apple, building the right infrastructure for a proper Internet search service would be a tall order. $20 billion a year from Google would only go so far as to build new internet infrastructure, not to mention the huge amount of software development needed on top of that.
Given this, I think Google will safely remain the default search engine over Apple for the foreseeable future (unless regulatory factors come into play first). Apple is probably more than happy to collect those annual payments of tens of billions of dollars from Google. I see the status quo in internet search staying intact for a while because it just makes financial sense for Apple and Google.