For years, tech juggernaut Apple has been building a services-focused ecosystem designed to offset bumpy, lumpy hardware sales and bring higher-margin dollars to its revenue streams.
Take, for example, its search capabilities. Google is the preset default search engine on Apple’s Safari browser via a longstanding agreement.
Apple has been posting double-digit growth in services through the past several quarters, but this momentum may be blunted by a landmark U.S. District Court ruling Monday (Aug. 5) that Google has acted as a monopolist, and by extension, its search agreement with Apple is anti-competitive.
Billions of dollars and several percentage points of Apple’s operating margin (and profits) may hang in the balance.
Among the anti-competitive findings in the opinion, U.S. District Judge Amit Mehta said default search agreements (the Apple/Google tie-up is one example here) deny Google’s competitors access to search queries and user data needed to improve their products and ad platforms.
“Most users access a general search engine through a browser (like Apple’s Safari) or a search widget that comes preloaded on a mobile device,” Mehta wrote in the ruling. “Those search access points are preset with a ‘default’ search engine. The default is extremely valuable real estate.”
The value of that metaphorical real estate runs both ways. Apple and Google entered into their current Internet Services Agreement in 2016. The ruling detailed that, per the deal, Google pays Apple a share of its search ads revenue in exchange for Apple preloading Google as the “exclusive, out-of-the-box default” search engine. The agreement is in place through 2026, and there’s an option to extend the joint efforts until 2031, via mutual agreement.
The agreement also “requires both parties to cooperate to defend the agreement, including in response to regulatory actions.”
For Apple, the impact of the agreement, and the dependence on Google, is sizable.
Mehta’s ruling detailed that “between Siri, Spotlight and Safari, Apple gets about 10 billion user queries per week. Roughly 80% of those queries are entered into Safari; Siri and Spotlight thus make up a minority of queries.”
As the default engine on Safari across all Apple devices, Google is an automatic responder to search queries unless users actively select different third-party services.
“In 2022, Google’s revenue share payment to Apple was an estimated $20 billion (worldwide queries),” the ruling said. “This is nearly double the payment made in 2020, which was then equivalent to 17.5% of Apple’s operating profit.”
According to Apple’s latest earnings report, the services segment accounted for 28% of the company’s $85.8 billion in net sales in the fiscal third quarter, growing by 14% year on year. The services segment carries gross margins of about 73% versus hardware margins of about 35%. The company offers only qualitative detail on its services-related revenues during conference calls (and in its filings).
The company’s latest annual filing with the Securities and Exchange Commission (SEC) noted that for the year that ended last September, the total services segment logged $85.2 billion in sales. If Apple loses $20 billion from its deal with Google, that would equal somewhere near a quarter of its services sales ($20 billion through the service agreement on $86 billion in services revenues), with gross margins that are rather high.
PYMNTS has reached out to Apple for comment.
The exact impact of curtailing or shuttering the Internet Services Agreement may be hard to pin down because the ruling’s impact and regulatory actions have yet to be known. But the old Wall Street saying is that it’s better to be directionally right than precisely wrong. In this case, the direction seems that there may be at least some near-term headwinds to a lucrative revenue stream that has been helping Apple move beyond hardware.
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