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The Android Income Statement

This is a continuation of the “Android Economics” series of posts. It deals with how revenues and costs are categorized for Android.

The following diagram shows an approximate representation of what Android’s “Income Statement”[1] would look like.

 

I’ll discuss the assumptions that are built into the model as I go along. I’ll begin at the upper left and move toward the lower right in the discussion.

The first thing to note is that sales from Google’s (formerly known as Android Marketplace) Play are not registered as revenues. This is because Google, like Apple, treats itself as an agent. Agency means that the revenues don’t “belong” to the agent but get passed on through to the primary beneficiaries. In the case of Play, Google passes 70% to developers (or content owners) and then distributes on average 25% to network operators (or carriers).

I emphasize on average because there are many cases where Play transactions are not handled by or don’t pass through operator billing systems. In those cases where operators are involved, it’s possible that they capture more than 25%. It’s not uncommon for operator billing to capture 45% of a transaction’s value. The reason for this is that there is significant collection risk on billing–far more risk than on credit cards. It would also imply that on some transactions Google may be paying out more than it receives.

This means that on average about 5% of Play content sales to be booked as revenues for Android.

This 5% ends up a quite a small amount if overall app sales are small. We don’t know the exact amount but anecdotal evidence from developers seems to indicate that they receive far more revenues from ad sales than from direct app income. Hence the size of the Android app sales is overall, modest. My estimate is that in 2011 there were about $330 million in gross app sales through the Android market. (Google estimated its sales to be 76 million for 2010 half way through that year.)

The bulk of revenues are therefore from other sources: Search, AdSense and AdMob. I’m modeling that overall revenues are based on a “revenue per device in use” multiplied by the number of devices in use. Google has publicly stated that they are targeting $10/device/yr. in revenues. This is probably ambitious as the amount was nearly that much in early 2010 but the number of devices bought by emerging market consumers exploded. As they are not actively targeted by Google’s primary customers (especially in China), the average revenue per phone is likely to be much lower. I estimated $6.5 on average for 2011.

However, even if we use $6.5 per phone per year, the total revenues are quite strong since there were likely more than 215 million users at year end[2]. That results in a total revenue base of $1.4 billion for 2011. Removing the app revenues results in about $1.38 billion from Search and AdSense and AdMob.

How to allocate revenues to these three businesses is mostly guesswork. I used a split of about one third to AdMob, 10% to AdSense and the rest to Search. If we assume this split then the next step is to consider how to allocate costs to these sources of revenue.

As discussed in the introduction to this series, the primary costs of sales for Search and AdSense are network operators and OEMs or phone vendors. They are the primary “channel” which ensure the flow of search terms to Google. As Google also explains, the channel receives revenue share–so-called traffic acquisition costs (TAC).

I used an overall allocation of 39% for TAC. Crucially, this includes the payments to developers for AdMob traffic. The rule of thumb I used was:

  • Network operators get 20% of Search
  • Developers get 50% of AdMob
  • OEMs get the rest (of the TAC)

The resulting split is shown in the column above with the “Cost of Sales” at the bottom. There are also additional operations costs which are negligible.

After this 39% TAC (revenue sharing), Google needs to pay its operating expenses. This includes R&D, Marketing, Sales and Legal costs for the Android division (including AdMob). You can see the approximate values in the column labeled “Operating Expenses”. This operating cost amounts to about 27% of sales, with R&D at 14% and Marketing at 9%. These rather high fixed costs make sense as there is a significant development work underway for Android.

Finally, after these costs are allocated, the remainder is the contribution of the division. This comes to about 34% of revenues which is called the operating margin. Google has to attach depreciation from data centers and other costs as well as taxes before placing this into earnings.

Considering the agency structure, the overall cost structure of Android looks like this:

When playing with the assumptions, it becomes clear that the model is most sensitive to the revenue per device and total devices in use. The profitability is entirely dependent on those figures as variable costs are a percent of sales and fixed costs are limited by talent constraints.

For example, if revenues per device drop to $4.5/yr then the operating margin drops to 38%.

Now we can calculate some of the more interesting figures. For example:

  • Android OEMs receive $0.76 on average per device per year
  • Android Operators receive $1.07 on average per device per year (including Play)
  • Android Developers, as a group, receive $1.94 per device per year (including Play and AdMob)
  • Google receives a contribution of $2.75 per device per year from Android

Again, these figures are very sensitive to the revenue per device (currently assumed to be $6.5).

Because of the number of devices involved, these cash flows are an important part of the value network of mobile computing. The next step will be to assess how they affect the incentives, alignments and competitive stance of various platforms vying for a seat at the table of the future of information.

Notes:

  1. An income statement shows the sources of revenues and the costs associated with those revenues. It also shows the fixed costs (or costs which are independent of revenues so they don’t go up or down if revenues change). Finally it shows the operating income which is called contribution if it’s a division within a company. This contribution is still subject to taxes and depreciation before it’s recorded as earnings.
  2. I’m using Android installed base estimated based on daily activation rates as published by Google. I’ve discussed these estimates here. I’m using year-end estimates but subtracting retirements based on a two year device life.

 

  • narbal

    Network operators getting a cut of applies mostly to U.S. only. Given that most recent Android growth has been from emerging markets, the 20% assumption for operator-cut seems high

    • narbal

      Disqus doesn’t seem to save my corrections.
      1) Network operator getting a part of search/ad mob/ad sense revenues applies only to U.S.
      2) >50% of all android phones are outside U.S.

      Outside U.S., TAC should be lower than 39% since the network-operators aren’t in the picture.

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

        Why do you think they are not part of the picture outside the US?

  • at

    Thank you very much for your brilliant analysis. Just one little question:
    “However, even if we use $6.5 per phone per year, the total revenues are
    quite strong since there were likely more than 215 million users at year
    end[2].”
    You take the number of users at the end of the year and treat it as if they would have been customers for all twelve months of the year? Given the growth rate and higer sales towards the end of the year that sounds a little bit strange to me. Am I missing something?

    • aharon

      Another question.215mm units x $6.5/unit it is not equal to 967billion.
      How do you get that number?

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

      I am using the end of year as an estimate. The absolute values are not as important as the ratios.

  • davlund

    Horace
    This is really fascinating stuff – thank you for sharing it. I think you mean “million” rather than billion in the sentence below though?
    Cheers
    “…there were likely more than 215 million users at year end[2]. That results in a total revenue base of $967 billion for 2011. Removing the app revenues results in about $958 billion from Search and AdSense and AdMob.”

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

      Yes, I fixed the error.

  • Mike Wren

    > Android Operators receive $1.07 on average per device per year (including Play)

    That doesn’t seem like much incentive for an operator to push Android phones compared to what the subscriber pays monthly.

    • Joe_Winfield_IL

      I had the same thought. Even at the low end, there is typically a subsidy in place on smartphones of at least $50. Spread over two years, this is still nearly 24x the $1.07/y from Google. I suppose something is better than nothing, but this revenue can’t possibly be influencing anyone.

    • Tim F.

      My guess is this exact point will be addressed in the subsequent posts in the series.
      For example, Horace has already alluded to the question of whether or not Microsoft has to provide the same incentives to make WP7 a success? (Likely answer: no, although it is a large percentage of Google’s Android-derived revenue, the revenue is negligible compared to standard operator revenue. In other words, it’s not these incentives causing operators to choose Android, it is the strategic flexibility of AOSP and outsourcing of software development/R&D that is the deciding factor.)
      What I think will be more interesting is modeling either increased revenue per user or userbase to get Android into “profitable” (or rather a significant contributing business unit — possible) or “competitive with Apple profits” (likely not possible). Does Android become a significant source for Google profits if they have, say, 80% of a 10 billion unit market — that is, assume their percentage of revenues retained remains the same, but scale surmounts the relatively small fixed costs, or do they need to boost revenue per user greatly to see a substantial payoff?

      Etc… Lots of interesting questions to ask and answers to tease out.

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

      The effect may be more psychological on the carriers’ management — the carriers, at least in the US, seem to believe they have an entitlement to a share of any value that flows across their pipes. Google is playing to this, and hence look like “team players” to the telcos, unlike Apple.

      The fact that Google has agreed that they’re entitled to be paid is probably more important than the current rates, since they can always change those whenever they’re in a better bargaining position. They can also use this as a bargaining chip against Apple (though right now the carriers are in a *very* weak position there).

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

      Those payments to Microsoft are from OEMs not Google. The balance of payments from Google to OEMs and from OEMs to Microsoft will be discussed later.

  • http://twitter.com/Malartre Carl Malartre

    Hi Horace, the color names are inversed here:
    http://goo.gl/fBBJ6

    Carl

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

      Thanks. I’ll fix that.

  • Gonji

    Horace, considering most of Android’s revenue comes from ads and search, maybe you could do an iOS Income Statement for Google to provide a comparison of how much money Google makes off the competing OS’s.

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  • Nigel

    Extremely interesting. One item that confuses me, however, is this statement:

    “That results in a total revenue base of $967 million for 2011.”

    The “Revenues” bar on your chart seems to indicate a number closer to $1.5 billion.

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

      The text was incorrect. I’ve made the changes.

  • Nigel

    I’m curious about what contributes to the significant risk of operating billing which in turn leads to Google giving up such a large percent of their app revenue to carriers. If anyone could elaborate on that topic I’d be interested in hearing more.

    It seems to me that by creating a billing system through iTunes that users have entrusted with a huge number of credit cards, Apple has lowered transaction costs enough to make the App Store profitable for them. In contrast, if Google has to rely on operating billing because of a failure to make Google Wallet successful, they make almost nothing from the app marketplace. The slight shift in costs has created hugely different incentives and priorities for the two respective app marketplaces.

    This makes me wonder why the iTunes store has been such a successful payment platform, where Google Wallet has not. Is it due to UX design?

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

      I’m not an expert on this, but I’ve been told that there is higher risk with collecting a phone bill than with collecting a credit card bill. I would like to learn more about it.

      • Walt French

        I’m sure this is true. In the past year, I’ve had to get several charges cancelled from my wireless statement, while in the decades of credit card use, we’ve only seen a couple of bad charges.

        But the claim sounds self-serving. AT&T was not just a passive participant, the way my bank was. They were fraudulent charges from “service” providers of $10/month ringtones, and worse, who struck deals with AT&T to bill customers who “opted” for charges because they didn’t say “STOP!” in the exact right way. Much of the lousy collection rate would go away if the carriers refused to invite shady operators to fleece their customers.

  • Anonymous

    Why don’t you consider US market only? You are diluting the estimates by including world-wide figures.

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

      Because I don’t have data for regions.

  • Oak

    Horace, I’m seeing your graphs posted around the web a lot, often by themselves, more or less as fact, often as factual evidence supporting further exposition. I’m sure this one will be no exception. Given the significant assumptions behind some of your charts, you might consider noting the assumptions, or at least making reference to “assumed data” on the chart itself, so a disclaimer travels with it. Obviously you aren’t responsible for misuse of your charts, but it can otherwise look like Asymco is claiming facts that you are not claiming as facts. TLDR: Your chart presents itself like facts, your assumptions are buried deep in paragraphs.

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

      I cannot enforce how my material is used. I hope that by putting my copyright on each image some people will be motivated to return to the source and find out how the data was created.

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

        I agree this is great stuff — and would be invaluable even if Google were NOT so secretive about the data. I think the responsible thing to do for bloggers amd journalists who want to use your hard work is to name you, link to your articles *and* urge readers to study it. That’s what I intend to do in a forthcoming article of my own — both to give you credit and to give my post credibility, because your numbers might otherwise be brushed off as wild speculation. FWIW I think them reasonable, even conservative, and the implications for OEMs are pretty serious, *especially* in light of the price-tags on newer Nexus devices. I’d be fascinated to know how LG, for example, can afford to make the cutting-edge Nexus 4 for an UNLOCKED retail price under $300. Presumably Google is making it attractive for LG, but *how?* One scenario that occurs to me is that LG was asked to provide it at cost in return for enhanced ad revenue sharing — plus the value that Nexus adds to the LG brand. But you have to wonder how this remarkable deal will alter consumer expectations. I mean, if HTC’s upcoming, 5.5 inch Butterfly gets offered for $299 _with contract_, that might have been perceived as quite reasonable a month ago. But now?

    • famousringo

      This is a common and intractable problem in market analysis. Half the internet seems to think that Millennial’s market share charts are representative of something more than Millennial’s ad sales, even though it’s quite obvious that it has many kinds of bias which make it a poor proxy for usage, market share, install base, or whatever else people think it implies.

  • Tatil

    I am a bit confused about your estimate of $6.50 per device revenue. On your post on April 2nd, Google’s revenue seemed to be only $1.70 per device. Even if I subtract the payments to OEMs, operators and developers at 39% TAC rate, the figure comes down to only $3.97. The older $1.70 estimate was based on the court filings, so the numbers should be fairly reliable. Why is there such a big discrepancy (2.3x)?

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

      The older estimate was much more speculative, based on what Google wanted the court to believe were its revenues. The more recent data is far more believable as it seems to come from internal documents.

      • Tatil_S

        I am not convinced that Google would provide “incorrect” numbers to a court, while internally using the “correct” numbers that are sure to come out during discovery. That could be construed as fraudulent. But let’s leave that aside.

        We know that iOS users on average spend more time on the web and they are heavy users of Google search. Many iOS apps also use Google’s AdMob platform and those users may well fetch higher ad rates than Android users due to their higher average income. The audited (I think) official Google mobile run rate is already announced to be $2.5 billion for 2011, giving Google roughly $7.50 revenue per iOS device by your calculation in your April 2nd post. The kind of makes sense, if $1.70/(0.61)=$2.80 is from Android before TAC. Now, if Android revenue is $6.50 per device, redoing your calculations seem to leave $4.00 to $4.50 per device from from iOS. Do you think ad revenue per iOS device is less than the ad revenue per Android device?

  • Walt French

    Horace, you’ve again done a great service by laying this out for all to study — and hopefully, you’ll get some crowd-sourced info to make it even better.

    I have several questions that may help. (Sorry, no added info!)

    1. The revenue per device targets make sense for developed markets, but it’s hard to understand Android’s ads being at all valuable in major Asian markets, for example, where a large fraction of the phones are sold. Is there any way to see the $ distribution of AdMob? If Android’s geo distribution is even more tilted to lower-income economies, and Android gets near-zero revenues in some, could your ad/search estimates be aspirations for the highest-income markets, lowering the average by as much as half?

    2. The Oracle-v-Google trial has disclosed a smidgeon of info about Android revenues, and my sense is that the judge is somewhat incredulous of Google’s figures. One possible explanation is that Google is low-balling them for the court; another is that Google is going for market share versus profitability to protect against the risk of major damages awards (which for some reason inexplicably seem partly tied to Google’s revenues, not estimated harm to Oracle’s business). If we take the very low unit estimates from your prior post, the fixed costs would’ve eaten up *ALL* profits, making Android into a scorched earth business model. Does that seem credible?

    3. In the context of a $2000/2yr contract, $1/year per handset to the carriers seems a bit laughable. Do you think that another commenter’s suggestion that this was a token, feel-good term is correct, or do you see this leading to a new twist in the business model? Likewise, how can a crumb like $0.76 to the OEMs be seen as anything more than a barely-subsistence-living figure?

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

      The data we have is limited to a fraction of 2010. At the time, Android was mostly in the US and their revenue per device was in the $9 range. Schmidt was musing about $10/device in perpetuity. I agree that it seems high for a billion Android users globally. The other way to back into this figure is to think about the “run rate” for Android that Google reports ($2.5 billion at last count.)

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

      I’ll address the tokenism question in a future post. I believe that these payments have not been as significant as perhaps early partners had anticipated. Certainly, in terms of value for the whole mobile product (hardware, service, apps), the portion Android represents is vanishingly small.

  • echotoall

    Cool analysis. Curious how u estimated the 35% reduction of device per yr ($6.5 vs 10).

    Seems like something very difficult to extrapolate. Given the growth dynamic of mobile ads, habits of users in different countries and the effect of 4.0 will have as it matures (which should be more effective on monitization as its user experience is better).

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

      It’s very difficult and a complete guess. It would be better to offer a range and calculate the results as a range. I consider 6.5 to be the middle of a range of values. There are other proxies such as measurement of browser shares or engagement for various platforms. We can try to calibrate to iOS figures for example, though they include tablets.

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  • http://twitter.com/Alishsayd Alisher

    Not bad, Horace, considering the limited info available in the public space. I would comment that you ought to use average install base as opposed to ending install base to calculate ARPU. You should also consider whether there are significant differences in monetization on Android vs iOS vs other smartphones. The $6.5 ARPU is the Android figure, judging by your post, and one could imagine that is significantly worse on bberry, symbian, and other smartphone platforms. As for monetization on iOS – that is a bit of a black box for me.

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  • Chaka10

    Horace, does your view of Android economics remain intact, directionally, a year later? Why does GOOG pay TAC for search to operators — how are they relevant for search after the handset is sold?

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

      In the absence of new data, the view has to stay intact. Do you have any data to suggest otherwise?
      Google pays TAC because access to traffic is not free. You have to consider that the “product” Google sells is accessible only through various contact points. The relationship with the end user is precious and one would be a fool to give Google access to that relationship without a fee.