Where Google Can Beat Apple: Mobile Advertising

These days, Apple's (AAPL) growth seems unstoppable. More than a million iPads were sold in their first month on the market, and many more will surely be sold during the remainder of the current quarter. Sales of iPhones are about to get a push from the next-generation 4G smartphone expected to be unveiled next month, which means more apps and music downloaded from Apple's online stores.

But every outsized hero has an Achilles' heel, and Apple is no exception. It took Google (GOOG), the search master, to find it.

Apple and Google are new and highly visible adversaries in the mobile Web arena. But what observers often overlook about their rivalry are their starkly different business models. Apple is still primarily a device manufacturer: 82% of its revenue comes from gadgets, 54% from iPhones and iPods alone. Google, by contrast, is an advertising company: 96% of its income comes from ads. The thing is, in the mobile Web business, advertising is a much smarter long-term strategy.

Yes, Apple is shaping market after market: MP3 players, browser-friendly smartphones, tablet computers. But even successful gadgets have depressingly short shelf lives. Either consumers move on to the next big thing -- as they did with the iPod -- or competitors quickly emerge with similar products -- as Palm (PALM) did with the Pre and Google did with its Android phones.

This cycle is destined to repeat itself with the iPad too, as competing tablets emerge. Eventually, prices will move lower and lower as tablet computers become commodities, and that will squeeze Apple's profit margins tighter. Apple has done a remarkable job of churning out innovative products while spending only 3% of revenue on research and development. But advertising offers more consistent, less cyclical returns. Google's operating margin, at 35%, is higher than Apple's 27% margin.

To Google, a Smartphone Is Just a Platform for Ads

This is why Verizon (VZ) selling two Droid phones for the price of one is such an ingenious strategy: It beefs up Android's market share, which helps Google serve more mobile ads. Google has said its entire mobile strategy is to, in its words, "accelerate the ecosystem" -- in other words, get as many Android phones as possible out there upon which to serve Google's ads.

And it's working -- the market share for Android OS phones recently surpassed that of iPhones. But if Apple wanted to counter with a similar 2-for-1 strategy, the move would hurts its profit margins. This is Apple's Achilles' heel.

Of course, Apple is moving into online advertising with iAd, which is based on technology Apple obtained in the January acquisition of Quattro. But Apple bought Quattro only after it failed to hook its first target: AdMob, which got snapped up by Google. That failed acquisition attempt only underscores a daunting reality Apple is going to have to struggle with for years: Google not only has a head start in the online ad business but it has a deeper understanding of what makes ads sell online.

Mobile advertising is something of a Shangri-la for online ad networks. According to the Internet Advertising Bureau, mobile ad spending totaled $416 million last year, a mere 1.7% of the $24 billion for all online advertising. But with more eyeballs drawn to display screens of smartphones, the figure is going to grow. The question is: How fast? That's where the disagreement comes in. Estimates range from $3 billion to $10 billion in 2013.

Wherever You Go, the Ads Will Know

Either way, it's not insignificant. Google's revenue was $23 billion in its last fiscal year, and Apple's was $43 billion. But there's another reason why mobile advertising is so coveted. Apparently, people click through more often on mobile ads than on ads served to desktops or laptops.

"We are starting to see much improved monetization in general across mobile," said Jonathan Rosenberg, Google's senior vice president of product management in Google's January earnings call. More recently, engineering Senior VP Jeff Huber said, "We are taking a mobile-first approach to most everything we do. That means doing things that take advantage of the unique characteristics of mobile smartphones."

What are those unique characteristics? Geolocation, for one: The GPS functions built into most smartphones allow ads to be targeted based on where the phone is at a given moment. Google has also been pushing its click-to-call function, which lets people call a retailer to place an order simply by clicking on an ad. The concept isn't new: It has been available on computers for most of the last decade, but in that medium, it never caught on. People have only recently become comfortable making calls on their PCs. The technology seems like a more natural fit for smartphones.

The Wrong Opponent?

Apple supporters might not agree that Google has a better long-term strategy for the mobile Web. After all, Apple has built a better mobile platform (or as Google would say, a "mobile ecosystem") for now. But the reality is that Android poses a bigger threat to the iPhone than Quattro's technology poses to AdMob's. One could even imagine Apple dominating the emerging market for mobile advertising if it were up against anyone but Google. But it is up against Google.

It may well be that Apple moves from idea to idea and market to market, radically transforming each one just as it has transformed music players, mobile phones and now tablets. That seems to be where its strengths lie. But in its attempt to reinvent itself as a mobile ad giant with Google as a rival, Apple may be biting off a little more than it can chew.