Categories

Android economics: An introduction

Android has had unprecedented growth. Based on activation announcements, it’s possible to estimate that thus far, about 370 million Android devices have been activated. The total number of devices in use is a lower figure which depends on replacement rate and retirement rate. This total number of devices in use at year end is estimated in the following chart.

I added the blue line which represents what Google had as an internal estimate in mid-2010.[1] The difference between the two lines shows that Android’s growth is far higher than what the company expected.  If the company itself did not expect this growth, it’s unlikely anybody else did either.

Unexpected, exponential user growth is usually accompanied by a dramatic positive improvement in the finances of a company and a higher return to shareholders. The curious aspect of Android’s success is that it has not had an impact on either. The market has not “discounted” the half-billion anticipated Android users into a price for Google shares that reflects this growth. It can only imply that those users are not very valuable.

But why would there be such a disconnect between the number of users and their value?

In order to answer this question we have to come to grips with what I call “Android economics”. We need to understand how Google uses Android to make money and whether it is succeeding and if it’s not, why not.

In many ways, the Android business model is straight forward. It’s an extension of the existing Google business model: Revenue is obtained from Search, AdSense and the applications that enable these two.  In the case of Android there is also revenue from app sales (Google Play a.k.a. Android Market) and from AdMob. Of course, all these revenue sources (except for Play) are sold through other mobile channels that include alternative, competing platforms. They are present on iOS, Symbian, BlackBerry and even embedded OS phones ranged directly by carriers. For each of these alternatives, Google pays for placement of their search as the default search in the browser.

To Google, total search revenue from iOS is far higher than it is from Android. That’s because iOS users engage more with their devices and there are not yet a large multiple of installed Android users vs. iOS users.

But it would make sense that having your own platform would be more economical because there would be none of these placement fees. In this sense Android is another “channel” for distribution of Search and AdSense. But one which may be a lot cheaper.

However, it turns out that it does not work that way. Android has other costs.

In fact, Android’s distribution costs might be higher than other channels. What we have to understand is that all of Google’s channel revenues have a “cost”. The revenue from a particular distributor of search results that Google generates is offset by the cost to acquire the terms. You can think of it as Google paying for the queries through a revenue sharing agreement. Google does not get search terms directly and depends on distribution. Overall, it pays about 50% of revenues back to distributors. In the case of its own web sites the rate might be lower, perhaps 40%.

Google even has a term for it: Traffic Acquisition Costs or TAC.

This revenue sharing in exchange for search terms extends to Android. Google pays about 40% TAC to Android distributors of those searches. But since Android is owned by Google, who does Google need to pay for traffic? Who is an Android distributor? Who gets the revenue share?

Google does not make a secret of it: network carriers and device vendors (OEMs) receive revenue share. From the latest earnings conference call:

Yes. I mean, again, I’m not going to talk about specific of the TAC on mobile. But as you know, we get people using our devices both organically as well as through our distribution partnerships with carriers and OEMs. And typically, the OEMs and carriers participate in some of the economics that are on the Android marketplace or Google Play and some of them participate in the economics around Google Search just the way we would do syndication on the Web platform, which you do with many partners around the world. We have similar deals on the mobile front.

- Nikesh Arora, senior vice president and chief business officer at Google Google Management Discusses Q1 2012 Results – Earnings Call Transcript – Seeking Alpha

Arora made another point in the quote above. Not only is there revenue sharing with carriers and OEMs for Search and AdSearch but also for Google Play (app and content sales.)

Device vendors and carriers get a cut. Google’s model has always been one of giving a cut of revenue to their upstream distribution. It just might be surprising to hear that device vendors like Samsung and carriers get a piece of Search and apps.

This basic observation leads to a series of questions:

  • How much is paid out and to whom?
  • Is that revenue sharing sustaining the ecosystem? Do vendors create Android devices and do carriers push Android to consumers because they get this revenue share or is the amount insignificant vs. device margin? What about tablets? Why haven’t Android tablets they taken off as Android phones have? Are the economics to blame?
  • Is this a competitive advantage vs. other platforms? Does Windows Phone compete with revenue share for Bing? Is Microsoft offering a bigger carrot (as well as a stick?)
  • How does this economic picture show up in Google’s financial and stock price performance? Or, more precisely, why doesn’t it?
  • And, finally, what conditions create a virtuous cycle of growth and what conditions could turn it into a vicious cycle of decline? Is there a lurking factor which would cause Google to benefit greatly from this user base or is there an inherent point of failure in the model?

I’ll be answering these questions in a series of posts this week.

Notes:

  1. Google’s internal documents were leaked as part of the Oracle trial (Exhibit 1061). They can be found by using Google search with the following search term: “OC quarterly review”.
  • Pingback: Asymco: Android economics

  • def4

    Actually, the first question that comes to mind is why is Google so generous?

    They are sharing revenue when they seemingly could simply keep all of the services revenue for themselves.
    Android is plenty attractive to handset manufacturers and operators as the only way to actually make money from products somewhat competitive with iPhone.
    After all, they are the beneficiaries of Android’s “open” status.

    • http://twitter.com/dr_stupid anna boros

      Because they want to give manufacturers a good reason to pick Android. Being the only alternative to iOS is a good enough reason for now, but that will change with the arrival of some other licensable OS.

      What I don’t understand is why they’re rewarding the operators. What’s their say in this?

      • Addicted

        At least in the US, operators are the biggest sellers of phones.

      • FalKirk

        “…why they’re rewarding the operators. What’s their say in this?”-anna boros

        The carriers are THE reason for Android’s large market share. Android and the carriers have a symbiotic relationship. Google is good to the carriers and the carriers are good to Android phones.

      • def4

        What licensable OS could possibly offer better terms than Android, both in terms of cost and flexibility available to implementers and distributors?
        The only apparent drawback of Android and advantage of Windows Phone seems to be related to patents.

      • pk de cville

        Another drawback:

        Win Mobile: Unified, Controlled

        Android: Got Fragments?

      • def4

        Fragmentation is a drawback for consumers and developers.
        For handset manufacturers and operators, it’s just a consequence of the crucial ability to customize that attracted them to Android in the first place.

      • Ravi

        Fragmentation isn’t entirely a drawback for consumers. Plenty of them like things like varying form factors and cheaper devices (which ultimately require cheaper parts).

      • http://www.asymco.com Horace Dediu

        I believe the point was that software and UX fragmentation is a problem for users and developers. That’s the hypothesis given what happened with Windows over most of its life. There were plenty of hardware choices but no software choice and that was a market winning strategy.

      • Ravi

        From what I’ve seen, at least some amount of software fragmentation is required to produce hardware choices – and the Android vs Windows Phone contract makes that obvious. There are all sorts of things vendors would love to include (e.g. dual-core CPUs, alternative screen resolutions) and/or would have loved to include sooner (e.g. LTE) that they didn’t because of Microsoft’s efforts to control fragmentation.

        It’s also worth noting that until Windows XP became established (i.e. long after Windows established its dominance) there was nothing (on the consumer side) preventing device drivers and other applications from going “behind the OS’s back” to do all sorts of things – and, in fact, this was a key thing that enabled many devices originally targeted for DOS to migrate to Windows in the first place. In other words, even Windows had plenty of OS-level fragmentation for most of its history (even outside of the various versions). You could even argue that Microsoft’s DOS/Windows strategy was to ride fragmentation to a position with some power, use that power to grow the platform and rein in fragmentation (though I’m not sure how much I agree with that).

      • Ravi

        P.S. Something is off in Firefox 12. I’m not getting any indication that a comment has been successful.

      • Ravi

        From what I’ve seen, at least some amount of software fragmentation is required to produce hardware choices – and the Android vs Windows Phone contract makes that obvious. There are all sorts of things vendors would love to include (e.g. dual-core CPUs, alternative screen resolutions) and/or would have loved to include sooner (e.g. LTE) that they didn’t because of Microsoft’s efforts to control fragmentation.

        It’s also worth noting that until Windows XP became established (i.e. long after Windows established its dominance) there was nothing (on the consumer side) preventing device drivers and other applications from going “behind the OS’s back” to do all sorts of things – and, in fact, this was a key thing that enabled many devices originally targeted for DOS to migrate to Windows in the first place. In other words, even Windows had plenty of OS-level fragmentation for most of its history (even outside of the various versions). You could even argue that Microsoft’s DOS/Windows strategy was to ride fragmentation to a position with some power, use that power to grow the platform and rein in fragmentation (though I’m not sure how much I agree with that).

      • Ravi

        Fragmentation isn’t entirely a drawback for consumers. Plenty of them like things like varying form factors and cheaper devices (which ultimately require cheaper parts).

      • http://www.asymco.com Horace Dediu

        The clue to the answer is by looking at the performance of the non-operator supported Android tablets.

      • http://twitter.com/dr_stupid anna boros

        For most Android users tablets are still luxury items, while phones are a necessity. So I don’t know if comparing their performances gives the right answer to this.
        Samsung and Google could sign a 5-year contract tomorrow, binding all Samsung phones to Android and leaving the operators out of the revenue splitting scheme.
        The question is: in this case, could an operator shun Samsung and refuse to sell their products?

      • http://www.asymco.com Horace Dediu

        Operators are primary decision makers on any device sold to their users. This is less important in countries where there are limited or no subsidies, but all operators prefer to decide which phones are on their networks.

    • FalKirk

      “Android is plenty attractive to handset manufacturers and operators as the only way to actually make money from products somewhat competitive with iPhone.”-def4

      Attractive? How so? As Horace has previously demonstrated, Samsung is making money (though 4 times less than Apple), HTC is barely breaking even and the rest of the Android manufacturers, for whom we have numbers, are losing money.

      • def4

        That’s true now, after the advantages of Samsung in hardware integration and scale have kicked in.
        Initially and up until this time last year, Android was helping HTC and Motorola get back into the game.

      • http://techtakes.net Arthur P. Johnson

        Bingo. And THAT is the secret which 99% of tech journalists seem afraid to reveal. Their ain’t no Santa Clause, kids. Google is pretending to make money from Android, but the Oracle court docs show it’s a sham, and their hardware adventure, while great for us consumers, is bankrupting their OEMs by forcing them to sell a breakeven simply to compete with the Nexus glamour-devices. This can’t last much longer than 18 months or so before the money boys flag it to a halt. It’s a bubble — buy the hardware but sell the stocks.

    • Tatil

      That “open” status allows the manufacturers or the carriers to change the default search engine on the browser very easily. Google may have to be give them a substantial cut. The display ads may be more difficult to interfere with, as they are part of the apps, but Google may not be as generous with those in the first place.

      • http://wmilliken.livejournal.com/ Walter Milliken

        I seem to recall that Google started tightening up on search alternatives after VZ defected to Bing; something about “no Google apps” without Google search. So if a carrier or manufacturer wants to replace Google search, they also have to replace maps, mail, etc. That’s a pretty high bar.

  • Sacto_Joe

    I’ve felt for a while now that the growth in the Android phone marketplace represents less a success for Google than an indication of just how massive the mobile market really is. Apple has been striving mightily to increase production for years now, and still finds itself unable to keep up with demand. It’s not at all an accident that Google is growing like Topsy into that demand vaccum.

    BTW, that is one of the primary reasons Tim Cook is such an excellent choice to head Apple following the passage of Steve Jobs.

    • http://wmilliken.livejournal.com/ Walter Milliken

      Apple doesn’t keep up with demand at iPhone launches, but they do seem to come into balance after a quarter or so, so it’s not clear if there’s a lot of upside to Apple’s market that’s being lost to manufacturing bottlenecks. (The iPad is a different story, but seems to be moving toward this model as well.)

      Apple’s demand increases seem to come somewhat from additional carriers, and also from organic growth, as well as decreases in entry price points. I think in the US, we’re also beginning to see a market share shift from Android to iPhone as disgruntled early Android users hunt for alternatives, though it’s not clear how big this effect is, yet.

      • Sacto_Joe

        Note that Apple left chips on the table in the Oct-Nov-Dec quarter. To some degree they cashed chips in the next quarter. But. In a nascent market, leaving chips on the table is synonymous with giving those chips to your competition. Apple needs to be able to handle even the largest bump in demand, or it is not matching demand: It is giving an opportunity to its competitors.

      • http://wmilliken.livejournal.com/ Walter Milliken

        I think the issue for Apple is much larger when they’re absent on a carrier, than with not producing enough iPhones. There doesn’t seem to be a lot of evidence that people choose other phones when iPhones are scarce, but there’s a lot of evidence they buy other phones when their chosen carrier doesn’t have iPhones. Apple does seem to be addressing this issue, though.

      • Rj

        That’s why Apple is working on making more devices, so they can add more carriers.

      • Luis Alejandro Masanti

        As far as I know, Apple is up to 250 carriers up from 500 total in the world (approx.).
        So, this becomes “chicken and eggs”: Apple is getting more (regional) carriers as fast as it can ramp up the building of devices.

      • Rj

        That’s why Apple is working on making more devices, so they can add more carriers.

  • Christian Lindig

    To understand Android as business I believe we must understand at the incentives for a number of parties: Google, carriers, programmers, handset manufacturers, and users. I understand the incentives for handset manufacturers: they get a mobile OS that is far better than anything they could develop inhouse and this makes them sell more hardware. Users get cheap and capable handsets (the cost from fragmentation is not yet too obvious to hem). Carriers might be attracted by cheap hardware (but might suffer from fragmentation in the long run). It’s far less clear what is in there for programmers as fragmentation hits them hard, as well as multiple stores and a culture of free apps. Yet, a mobile platform like Android needs programmers to survive. Since Google creates Android they foremost must have some incentive. Is it strategic? Or is there money to be made from it today? There are numbers reported that Google makes in the order of $10/year revenue from search and ads per mobile device. This seems awfully low to justify the development cost of Android and the acquisition of Motorola Mobility. I am really looking forward to this series of articles and hope it will shed some light on the overall business of Android, not just from the perspective of Google but all parties involved.

    • Christian Lindig

      I’m sorry for the many typos. Somehow Disqus does’t save my corrections.

  • Jesper

    Very much looking forward to this analysis. Judging by your questions, it would appear you are contributing to the quantification of coopetitive strategies.

  • sigaba

    Mobile search growth versus acquisition costs seem to be a Red Queen problem for Android and Google, they have to run to stay in place, and running faster is just a symptom of how hard it is to stay in place.

  • Mike Wren

    > Why haven’t Android tablets they taken off as Android phones have?

    Few customers buy tablets from carrier stores. Tablets are used for apps and content which is the reason only Apple and Amazon have been successful in the tablet market.

    > To Google, total search revenue from iOS is far higher than it is form Android. That’s because iOS users engage more with their devices…

    Many Android customers use their smartphone like a feature phone for phone calls and texting. So they don’t do many Google searches so Google doesn’t benefit and they don’t install many apps.

    The only company making any real money off of Android other than Amazon is Samsung. Samsung might fork Android to gain control. Or they might push their new Linux based open source OS Tizen. I don’t understand why Samsung has succeeded while HTC and Motorola have failed and look forward to Horace explaining that. And why does Google think it can do better by owning Motorola?

    • r.d

      Samsung has copied Apple most thoroughly while HTC
      and Motorola have same player with niche devices.
      While Samsung makes its own Screen, Memory, Flash, ARM SOC.

      Google bought Motorola because it fancies itself as the next Apple
      and as well as it thought motorola’s patents would protect against
      both Microsoft and Apple.

  • Knut finell

    Can’t wait to read the rest!

    • FalKirk

      Agreed.

  • delmiller

    If we are discussing how much money Google makes from Android, does it then matter that much of the Android revenue reflects an offsetting loss in revenue from web search?

    I would suppose that every search conducted on a phone is one not made on a PC and hence the value of Android search has something like an opportunity cost associated with it. I have no idea how that would be calculated without some assistance from Google’s bookkeepers.

    • Ravi

      The best camera is the one you have with you. The same is true of a search engine. I’d bet many mobile searches are ones that just wouldn’t have been made without the available device. For a mobile search to substitute for a desktop one it generally has to be a search you otherwise would have made in advance or one you would have remembered once a desktop was available. Both variants are not that common, in my experience.

      • delmiller

        Ok, but smartphones and tablets are a growing market and desktops an laptops seem to be either declining or not growing. If, on the hardware sales side, desktops and laptops are losing out to mobile devices it seems like a sort of zero sum game. And the conventional PC business is on the losing side.

  • Chandra

    I wonder: If Samsung and HTC get a cut of ad revenues from Google, it will not be long before HP and Dell demand a cut for search revenues from laptops and desktops!
    And Comcast and Time Warner too!

    • http://wmilliken.livejournal.com/ Walter Milliken

      The ISPs have indeed been looking to find ways to take money from the traffic they carry, and Google has been mentioned prominently in some ISP rhetoric. This is, in fact, much of what’s behind the “net neutrality” debate — the carriers (telco and cable) want to get paid not per bit, but as a share of the value of those bits (which is the classic telco and cable services model). They don’t want to be FedEx, being paid only by volume, they want to be customs agents, with a tax at their network borders.

      And I wouldn’t be too surprised if Microsoft were paying manufacturers to keep Bing as the primary search engine on their machines. Though Microsoft may be more likely to enforce that with their usual Windows monopoly stick.

    • http://www.asymco.com Horace Dediu

      You can only “demand” what you can get. It all depends on your negotiating position.

    • Luis Alejandro Masanti

      As far as I know, Apple gets a “cut” from Google by using its search engine in the browser.
      Could HP/Dell put Chrome as the defat browsrt in their computer?
      (I think they couldn’t.)
      So, then, they could get a “cut.”

  • vladiim

    Thanks for unpacking the complicated nature of Android’s business model Horace. I think this goes to show how difficult it is to pose any threat to Apple’s strangle-hold of this market.

    The barrier to entry is extremely high. Look at Microsoft’s efforts. On top of paying OEMs they’re offering subsidies to app developers to kick start their developer relationship which seems like a lost cause to me.

    The learnings I took out of this is to compete in the mobile OS market you either need to create a massive cost center (Android, Microsoft) or disrupt (Apple).

  • tedcranmore

    “higher than it is form Android” …..typo

    Why are Andoid tablets doing so much worse than android phones? I think far too many android phone purchasers were just looking for a cheap smartphone — most don’t even use it as a true smartphone. You don’t get the same boost of these types of sales in the tablet market and it shows in the numbers how significant this group is. When you buy a tablet you know what you want and know the tablet market as opposed to simply getting what is cheap and pushed by your carrier.

  • Chandra

    The point Horace makes sheds a lot of light on the ramp up of Android over the past couple of years. Android is the Traffic Acquisition Vehicle (TAV) for Google. There are two cost component to the cost. The Android development cost plus the payout to manufacturers and carriers for carrying the free Vehicle. Google pays the carrier since carriers have a lot of control over the manufacturer on these matters. A carrier can say ‘I would not carry your phone if you did not make Google as the default search engine’. That carrier payout by Google incentivises that behavior by the carrier. All makes sense.

    So this revenue sharing is similar to the AdSense payout though in this case it happens with search itself rather than clicking on ads. I suppose Google gets paid if I click on a link in the main ‘unbiased’ search results if that link happens to be an advertiser. I typically only see one sponsored ad at the top with Mobile Safari search. In my case I rarely use mobile search and even when I do, I rarely click on the Ad link.

    In case of iPhone, Google pays Apple for that privilege. They seem to have strategically placed themselves.. Of course, Google’s fate lies in the hands of Apple and that is something Google does not relish.

    All of the above obvious thoughts lead me to this question.

    Carriers do not have any direct incentive to sell iOS but have a lot of direct incentives to push Android. Customers love the iPhone and demand the iPhone in spite of the above.

    Why does not Google think that customers love Google search and demand Google search be available? Why do they have to go through all these extraordinary mechanisms for that to happen.

    There is something fishy here. Aren’t these the types of activity by the ones in control create regulatory action? May be what will happen is, as part of the phone configuration and activation procedure, these carriers will be forced to configure a search engine that the customer wants.

    • Ravi

      As was demonstrated with the Mozilla deal, a big reason Google pays for placement is that Microsoft (and Yahoo, DuckDuckGo, etc to a lesser extent) stand ready to pay for it if they don’t. Even if Google is the best and many users would change an alternate default to Google (which Google likely believes), there would be many who wouldn’t (because of laziness, lack of sophistication, etc) and that could be a large enough missed opportunity to make a substantial revenue share worth while.

  • Pingback: The Android Income Statement | asymco

  • Joe_Winfield_IL

    Google isn’t generous, they are spending as little as possible. Keep in mind that Android is open source. If Google stops placating the carriers and OEMs, there are two outcomes – both of which have already occurred in some scale:

    1) Carriers (who actually buy the phone from OEMs in massive quantities) force the manufacturers to load Bing onto their phones. Microsoft is VERY eager to force its product onto Google’s devices.

    2) OEMs fork Android in a way that hurts Google, removing Google services in a bid to differentiate a new, proprietary brand.

    So now Google has paid billions to develop Android, billions to “protect” it through the Motorola acquisition (plus unknown amount in courtrooms), and billions in TAC for traffic the company could have acquired without a mobile OS.

    • Ravi

      Given Google’s success in courtrooms to date, I strongly suspect their non-Motorola legal expenses are a rounding error in the big picture.

  • Pingback: Monday links: hedge, not a hedge | Abnormal Returns

  • westech

    Horace, I have a problem with your Android Growth Chart. Google (Android) says that they have activated 370 million units, and according to the blue line about 175 million are still active. The ASYMCO (yellow) line indicates that in 2012 about 500 million are still active. This is more than the number of Android devices sold. I suspect that the yellow line is mislabeled. Could you please clarify this for me?

    • http://www.asymco.com Horace Dediu

      The yellow line shows current estimate of end of year total installed base. The blue line is the same data but from an estimate made two years ago. So the Yellow line shows that by the end of 2012 there will be about 500 million installed Android devices while the Blue line shows that in 2010 Google believed they would have 175 million users by end of 2012.

  • Pingback: Even Google was blindsided by Android’s success » Any Problem? in Any News?

  • Pingback: Even Google was blindsided by Android’s success

  • Pingback: Even Google was blindsided by Android’s success : Pillalu.com

  • Pingback: Ripley's Blog | Ripple's Web » Even Google was blindsided by Android’s success

  • Pingback: Even Google was blindsided by Android’s success | News24

  • Pingback: This and that | Ripple's Web » Even Google was blindsided by Android’s success

  • Pingback: Even Google was blindsided by Android’s success |

  • Pingback: Even Google was blindsided by Android’s success | Every Single HOUR!

  • Pingback: 페이스북의 도전: 검색서비스와 자체 스마트폰 | 베를린로그 by 강정수

  • Pingback: Even Google was blindsided by Android’s success « GuruSpot: Gadget

  • Pingback: @VentureSquare – 페이스북의 도전: 검색서비스와 자체 스마트폰

  • http://www.articledashboard.com/Article/SAT-and-Cable-Liverpool-s-Leading-Retailer-of-Satellite-and-Cable-Products/2960797 Flytouch 7

    I have read your great article which given here, I have to say that The Android gadgets is strong competitor for another gadgets because Android devices are so popular day by day in the world. I am sure that Android devices are much better than other devices.

  • http://techtakes.net Arthur P. Johnson

    Bravo. AT LAST a responsible journalistic following the money to find out how much green stuff Android really generates — for Google and for OEMs. I wasn’t surmised when Google got into the hardware business, because the court documents reveal how shockingly small their ad profits are from Android handsets. But I was blown away by Google’s decision to follow Amazon down the “break even” path. First, because the economics are extremely unlikely — to make a decent profit on a $199 device sold at breaks even, you have to book amazing follow-on revenue, amounting to something like 10 books sold on average to every device-buyer. Well, MAYBE that’s okay for Amazon, who’ve been selling high-margin content since day one. I would expect more like 1.9 books per Kindle buyer over an 18 month amortization cycle — a fifth of what’s needed to make your stock attractive. But for Google? Since when have they made ANY money selling content? Hey, they’re the folks who give me stuff for free! So Google is wasting precious time on the failed Android experiment. and their decision to break even on hardware sales is questionable at best. But for OEMs like HTC, LG and yes, even Samsung, this has to be ruinous. Because they do NOT sell content — not seriously profitable content, anyhow — and now they must compete with Nexus devices that are media darlings and allow for 0% profit. It’s the PC race to the bottom repeated, in ultra-fast forward. In 12 months I see HTC either filing for bankruptcy or selling out to some unexpected, well-heeled buyer with very different plans