Google's $5 billion fine: What you need to know

Key Points
  • The EU slapped Google with a $5 billion fine for competition abuses related to its Android phone software.
  • Google is disputing the claim that its bundling of services is bad for the market.
Sundar Pichai, Google CEO
David Paul Morris | Bloomberg | Getty Images

On Wednesday, the European Union slapped a record 4.34 billion euro ($5 billion) fine on Google for using its Android phone software to stifle competition.

EU antitrust regulators ruled that the company, whose Android software powers more than 80 percent of the world's smartphones, pushed consumers to its search engine, further weakening rival search providers and app makers.

"Google has used Android as a vehicle to cement the dominance of its search engine," Margrethe Vestager, the EU's competition commissioner, said in the decision. "These practices have denied rivals the chance to innovate and compete on the merits."

While Google plans to appeal the ruling, the decision as it stands could have wide implications for the company's advertising business, as well as for phone manufacturers and app developers.

What did Google do?

The EU has a fundamental problem with the agreements between Google and phone makers like Samsung over the use of Android.

Although Google offers the open source mobile software for free, the EU takes issue with the requirements placed on manufacturers to pre-install Google's search and Chrome browser apps if they want to license the Play app store. Google actually ties Play to a suite of 11 different apps, including Maps, Gmail and Docs, but the only ones that the EU has called for it to separate from Play are Chrome and Search.

The EU also says that it's illegal for Google to pay manufacturers and carriers to exclusively pre-install Google's search app on phones, which it says it did between 2011 and 2014, and to use so-called anti-fragmentation agreements to prevent phone makers from selling modified versions of Android.

What's Google's argument?

In a blog post on the ruling, Google CEO Sundar Pichai said that Android has increased competition, not diminished it.

Google's main rebuttal is that Android users can easily remove the pre-installed apps and download third-party alternatives. According to Pichai, a "typical Android user" installs 50 apps.

Pichai said that phone manufactures can also choose to modify Android, citing Amazon's line of Fire products (though he doesn't mention the EU's accusation that its agreements with phone makers kept other manufacturers from making phones with FireOS), and that Android has compatibility rules to ensure that app developers' products work across devices. 

Notably, Pichai implied that forcing Google to stop bundling could prevent it from offering the Android software for free.

EU Commissioner Vestager: Google fine reflects long-standing abuse
EU Commissioner Vestager: Google fine reflects long-standing abuse

Although Google doesn't make money from Android directly, it generates advertising revenue through search as well as Chrome, Maps and Gmail. The company serves ads within those apps and uses data it collects from users to better target ads across its platforms. Google also gets a cut of revenue from app downloads or subscriptions through its Play store.

"So far, the Android business model has meant that we haven't had to charge phone makers for our technology, or depend on a tightly controlled distribution model," Pichai wrote.

What does this mean for Google?

Alongside the initial fine, Google is potentially faced with additional penalties.

If it doesn't change the conduct, as required by the EU, within 90 days, the company could face charges of up to 5 percent of the average daily worldwide revenue of Alphabet, Google's parent company, despite its appeal.

Google will get to decide how it changes its practices to comply with the EU's decision and those changes will then be evaluated for compliance. That process can take years: The EU is still deciding whether changes Google made after last year's $2.7 billion fine over the company's comparison shopping service are adequate.

The biggest potential risk for Google is to its advertising model. Google's ad business is growing much faster on mobile than desktop and, by bundling its apps together, the company has more real estate to sells its ads and more opportunities to ingest data.

"Worst case is that they'll be making less revenue from mobile," said Matthew Newman, an antitrust correspondent at MLex, a market insight firm. "Right now, it's extraordinarily hard to quantify what that could look like, since we don't know how phone makers are going to react."

For example, phone makers could still choose to voluntarily pre-install Google apps, despite this ruling. In its blog post, Google said that a typical Android phone comes pre-loaded with "as many as 40 apps from multiple developers." Alternatively, manufacturers could auction off specific app categories to app makers.

While some app makers have cheered this potential outcome, because it could theoretically level the playing field, skeptics say that the decision might be too little, too late.

Consumers in the EU may already be too entrenched in Google services to start using other apps, even if Google's options are not pre-installed.

"The consumer is likely to just simply download the apps for Google’s services if and when they get new Android phones," analysts from Credit Suisse wrote in a note to investors, "Much as they already do when they get new iPhones."

Analysts for Raymond James wrote that they expected "losses to be minimal" to Google's search revenues in Europe if it has to unbundle its apps, because the search engine has more than a 90 percent marketshare there.

Alphabet's stock dipped less than a percent in pre-market trading after the announcement and was trading slightly higher than the previous day's close by Wednesday afternoon.

Why is the fine so high?

In a news conference about the decision, Vestager called Google's behaviors a "very serious infringement."

“The fine is simply bigger because the effect of the infringement is bigger,” she said.

The fine of $5 billion represents about 40 percent of Alphabet's net profit last year, and less than 5 percent of the $102 billion in cash and short-term investments Alphabet had on hand last quarter.

The company said it would report a separate operating expense line on its income statement in its upcoming second quarter earnings to reflect the charge, which is not tax deductible. Google is appealing the ruling, but that money will remain in a holding account until a final decision is reached.

Meanwhile, the EU is still investigating a third antitrust case against Google's search advertising service, AdSense.