Google and the European Commission: US $5 billion fine shifts business strategy

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| The European | 18th October 2018
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The businesses of tech giants (Google, Intel, Microsoft, Facebook, and others) operating in the European Union are monitored by the European Commission, which is the European Union watchdog tasked with ensuring that (all) companies comply with the European Union antitrust rules.

 

Smartphones have revolutionised the method of harnessing information. Information is accessible just by “tapping” on the screens of smartphones. Two popular operating systems run smartphones. iOS (Apple operating system) runs devices manufactured by Apple Inc. Android, an “open source” operating system designed by Google, powers different brands of smartphones including Samsung and Huawei. The Android operating system has captured 80 percent of the market share of smartphones.

 

Google, the undisputed king of computing and mobile world, is in the crosshairs of the European Commission. The core of the latest scuffle between the European Commission and Google is that Google Search and Google Chrome (the popular web browser of Google) come pre-bundled with smartphones that run Google’s Android operating system.

 

Search engines are twenty-first century’s encyclopedias and web browsers make these encyclopedias accessible. Google generates (advertisement) revenue through Google Search and Google Chrome by using different algorithms (Pay per Click, Cost per Thousand Impressions).

 

CNBC (28 July 2018) reported:

 

“European Union regulators have slapped Alphabet-owned Google with a record 4.34 billion Euro (US $5 billion) antitrust fine for abusing the dominance of its Android mobile operating system, which is by far the most popular smartphone operating system in the world.

 

Google said in a statement that it would appeal the ruling, arguing against the EU’s view that its software is restrictive of fair competition.

 

European officials say Google’s parent company has unfairly favoured its own services by forcing smartphone makers to pre-install Google apps, Chrome and Search in a bundle with its app store, Play. It also said Google violated competition rules by paying phone makers to exclusively pre-install Google search on their devices and preventing them from selling phones that run other modified, or “forked,” versions of Android”.

 

The revelation by the European Commission that Google violated competition rules by paying smartphone manufacturers to pre-bundle Google Search and Google Chrome in their manufactured devices is the most alarming disclosure.

 

Immediately after the European Commission’s ruling, Google’s CEO Sundar Pichai tweeted:

 

“Rapid innovation, wide choice, and falling prices are classic hallmarks of robust competition. Android has enabled this and created more choice for everyone, not less. This is why we intend to appeal today’s Android decision.”

 

CNBC (28 July 2018) further reported:

 

“The European Commission ordered the company to put an end to illegal conduct within 90 days, or else face additional charges of up to 5 percent of the Alphabet’s average daily worldwide revenue. The EU fine is the largest ever issued to Google, which last year was served with a $2.7 billion penalty for favouring its shopping service over competitors”.

 

Company Financials

 

The latest financials (second quarter 2018) of Alphabet, the parent company of Google, report a net income of US $3.2 billion. It is important to note that this amount is after accounting for the US $5 billion fine imposed by the European Commission. The diluted EPS was US $4.54.

 

If the effect of the European Commission fine is factored out, then the diluted EPS increases to US $11.75, which by all means is an impressive figure. The most important thing is that the results exceeded the market forecast.

 

Latest News

 

Reuters (16 October 2018) in its report states:

 

“Alphabet Inc’s Google on Tuesday revamped how it distributes its mobile apps in the European Union, introducing a licensing fee for device makers to access its app marketplace in a response to regulators’ findings that it had broken the antitrust law”.

 

It is a clever move on the part of Google. Google Play is the Mecca of Smartphone Apps. Google had to relinquish pre-bundling of Google Search and Google Chrome but created a new stream of earning by charging phone manufacturers for accessing Google Play (app store).

 

Hiroshi Lockheimer, Google Senior Vice President, says (blog post):

 

“Device manufacturers will be able to license the Google mobile application suite separate from the Google Search App or the Chrome browser. Since the pre-installation of Google Search and Chrome together with our other apps helped us fund the development and free distribution of Android, we will introduce a new paid licensing agreement for smartphones and tablets shipped into the European Economic Area (EEA). Android will remain free and open source”.

 

The “license fees” have not been disclosed yet.

 

The Blog further quotes Hiroshi Lockheimer saying:

 

“We’ll be working closely with our Android partners in the coming weeks and months to transition to the new agreements.”

 

Market analysts

 

Reuters report quotes two analysts commenting on this shift in Google’s business strategy.

 

James Cordwell, a financial analyst at Atlantic Equities (US equity brokerage firm, based in London) says:

 

“The new arrangement simply changes the implicit exchange of value – access to the Play store in return for pre-installing Google Search and Chrome – into an explicit one (license fees for accessing Google Play)”.

 

Geoff Blaber, a technology analyst at CCS Insight, said:

 

“Google has found a way to make sure the Android continues to work in its favour”.

 

Impact on Google of this shift in business strategy

 

Google filed its appeal last week. It does not want “head-on collision” with the European watchdog. The shift in business strategy is a positive move.

 

The European Commission monitors compliance but does not delve into the mechanics of compliance. However, the final compliance check does consider feedback from the users of the product/services. Google will not get an easy pass.

 

The smartphone manufacturers might not be pleased with this new business strategy. License fees for Google’s product offerings will increase smartphone production cost.

 

If the added cost is transferred by smartphone manufacturers to their buyers then the European Commission’s ruling will not be implemented in its true spirit.

 

The new licensing agreement will come into effect on October 29, 2018, for all new smartphones and tablets launched in the European Economic Area (EEA).

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