Should Apple create its own search engine and exclude Google from the mix?

Rumors abound regarding Apple (AAPL -1.51%) and new technological equipment. Do you 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 -1.40%) (GOOG -1.39%) and his primary breadwinner, Google. But would Apple really make such a move and kick Google out of 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 keep them there. It’s a classic land-and-expand strategy: once a sale hits (an iPhone, say), Apple can then push other types of devices by touting how tightly they all are. integrated.

But the device-centric business model has slowly evolved over the years. Software and other revenue not related to the sale of a computing device – the services segment – generated revenue of $19.6 billion in the third quarter of Apple’s fiscal year 2022 (which is ends 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 worldwide installed base of devices currently in use (comprising 2 billion active devices, the majority of which are 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 indicate it would be $15 billion in 2021, rising to a range of $18-20 billion in 2022.

In other words, a significant portion of the growth of Apple Services (and a significant portion of this revenue segment overall) comes from Internet search advertising.

Given that Apple tightly controls its device ecosystem, why not just use those high 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 quite a large profit, even after the considerable 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 the source of Apple’s royalty estimates. Google’s TAC exceeded $24 billion in the first half of 2022, according to Alphabet. 30% worldwide (Alphabet’s Android making up the balance), estimates imply that around 40% of that TAC (or $18-20 billion) accrues to Apple each year.

Is Apple already preparing the ground for a search engine?

Apple could already be testing the waters for a competing Internet search engine. After all, there is already antitrust regulatory scrutiny over Apple accepting payment from Google in the first place. But aside from that, Apple has already been monetizing search through ads for years in its App Store. Software developers can pay Apple to promote their app so that it reaches more eyeballs of Apple users.

But there’s also Apple’s new Activity Tracking Transparency (ATT) feature (it’s a prompt that Apple sends to you asking if you want to sign up for an app that tracks usage activity of your device). Apple touted this feature as proof of how important it is to 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 base of devices. . Given that device sales as a whole have slowed down over the years, and given Apple’s growing focus on services, building its own ad 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 into targeted advertising internally with the help of ATT, while making it harder for Google, Metaplatforms (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 link 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 a clash between Apple and Google. However, cataloging the Internet itself is a colossal task that requires the ability to collect and process a staggering amount of data. Google owns a few dozen 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 good Internet search service would be a difficult task. $20 billion a year from Google wouldn’t go the extra mile in building new internet infrastructure, not to mention the huge amount of additional software development needed.

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 these 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.

Suzanne Frey, an executive at Alphabet, is a board member of The Motley Fool. Randi Zuckerberg, former director of market development and spokesperson for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a board member of The Motley Fool. Nicholas Rossolillo and its clients have positions in Alphabet (C shares), Apple and Meta Platforms, Inc. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Apple and Meta Platforms, Inc. The Motley Fool recommends the following options: long calls of $120 in March 2023 on Apple and short calls of $130 in March 2023 on Apple. The Motley Fool has a disclosure policy.

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