The Mobile Migration Challenge

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The mobile migration is well under way. It’s only a matter of months now, before worldwide sales of mobile devices exceed PCs, just as they have in India. Billions of people with “dumb-phones” will switch over to smartphones in the next few years. Tablet sales are expected to double this year compared to last year. With the rise of mobile, advertisers, such as Google (NASDAQ: GOOG), must adapt and step up to the challenge.

That’s not to say Google has stood idly by as smartphones and tablets find their ways into more and more households. In fact, its Android operating system dominates the world smartphone market with a 72% share last quarter compared to Apple’s (NASDAQ: AAPL) 14%. The challenge Google faces is in profitability.

In Goldman Sachs' (NYSE: GS) latest report on the computing market, the company points to some specific challenges Google faces. Here, I’ll go over them, and show what Google is doing to overcome those challenges, and how it presents opportunity for investors instead of weakness.

Smartphone Shipments VS Mobile Internet Traffic

While Google led the way in terms of total devices sold with the Android operating system, it failed to garner a majority share of mobile internet users on its OS last quarter. Instead, Apple saw 60% of mobile internet traffic through its iOS devices.

This is important for two reasons. First, Google does not make much profit on its device sales. The company gives away its Android software to manufacturers for free, and its own Nexus line is sold at near-cost prices. The idea is to get its product into more hands, and then get them searching. While the first part of the plan has been wildly successful, for whatever reason, Android users are not using their devices for searching the web.

The opportunity for Google lies in expanding and aggressively marketing its Nexus product line. By creating a product that’s specifically geared toward mobile web browsing and searching, Google should be able to increase its mobile internet share. This stands in contrast to Amazon’s (NASDAQ: AMZN) popular Kindle Fire line, which markets itself as a media consumption device, and is likely one of the main culprits for the low number of Android users browsing the internet.

The second reason the internet traffic disparity is important for Google is that it must pay a traffic acquisition cost to Apple in order for it to be the default search engine on iOS devices. Goldman estimates more than 75% of mobile ad revenues from iOS devices are used to pay this acquisition cost. Clearly, it’s hard to make a good profit margin when that much is taken off the top.

I don’t believe the acquisition costs Google must pay to Apple and other mobile OS developers is as big of a problem as Goldman makes it out to be. Google pays similar acquisition costs to make its product the default search engine for numerous web browsers such as Mozilla’s Firefox. These costs have become a much smaller part of revenue over time. The real problem is that prices on mobile ads are significantly lower than desktop advertisements.

Mobile Cost-Per-Click is 30%-50% Lower

In fact, lower pricing on mobile advertisements compared to desktop advertisements is the next issue Goldman brings up. This is the main problem people usually think of when the mobile monetization challenge comes to mind. Yet, in my opinion, there is no company in a better position to improve that CPC number than Google.

Google faced a similar challenge in the past. A decade ago, desktop advertising generated significantly lower margins for Google compared to today. Companies were still putting their advertisements in magazines and newspapers. As the company came public, and the internet grew in popularity, first with users, and then advertisers, Google saw its margins improve along with its stock price.

There’s even greater opportunity for advertisers on the mobile platform. Smartphones generally have built in GPS chips to determine location, allowing for location-based advertisements. In addition, Google’s large market share lead in devices sold, allows them access to a bevy of other information like app purchases and how people use their smartphones. Once Google determines the most effective way to harness all the information it gathers from mobile users, ad prices will undoubtedly rise along with their efficacy.

In order to accelerate this effort, Google Venture recently invested $10 million in Adelphic Mobile – a mobile advertising analytics company. The company is focused on making more mobile advertisements that are actionable. In other words, it provides users with a product or information that they want, and allows them to make a purchase, or sign-up for a newsletter, or whatever action the advertiser wants the user to take. In this way, advertisers would be willing to pay more per click, for advertisements that are more actionable.

No Popular Tablet

Apple’s iPad is undoubtedly the market leader in tablets. The company accounts for over 50% of total tablet sales even while selling them at a premium to its competition from Amazon and Google. Apple’s brand loyalty is what worries Goldman the most. As tablet sales increase dramatically year after year, those that buy an iPad are more likely to buy an iPhone for a more integrated experience between their computing devices, thus cutting into Google’s share lead in handsets.

For some reason, Goldman seems to preclude the idea that growing tablet sales can be good for every company involved in the industry. Moreover, Android devices such as Google’s own Nexus tablets and Amazon’s Kindle Fire line are growing sales faster than the iPad. Research firm IDC expects Apple to lose about 3% of its market share directly to Android devices this year. However, both improved revenues as tablet sales are expected to double this year over last year.

What’s really important for Google is increasing the number of users accessing its mobile search engine. Companies will eventually go to where the users are, and spend more advertising dollars there. This will help mitigate the acquisition fee the company must pay to become the default search engine. What’s more, the gain in market share shows that Google can succeed without a specific tablet to fuel Android sales, and means fewer acquisition fees paid to Apple.

Stepping Up to the Challenge

Challenges can either expose companies’ weaknesses or present them with great opportunities. For Google, I believe the mobile migration is a great opportunity for the company. Certainly, the company is not without its problems in mobile monetization, but it is in a position to capitalize greatly on the increase in consumers buying tablets and smartphones. The obstacles Goldman Sachs points to are indeed very real, but Google is well aware of its own challenges and is already combatting them to turn them into opportunities.


adamlevy owns shares of Amazon.com. The Motley Fool owns shares of Apple, Amazon.com, and Google. Motley Fool newsletter services recommend Apple, Amazon.com, Google, and Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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