Google's (NASDAQ:GOOG) Eric Schmidt recently predicted that there would shortly be one billion phones using the company's Android operating system. That's an impressive number and shows that the toll-taker model is winning again.
A Small Fee
Google rose to prominence because its search engine proved the easiest way to find things on the web. It became a real business by charging advertisers to display tiny ads next to its search results. It turned into a profit machine by opening its advertising technology to others.
Basically, it provides the technology and shares the profits for every ad shown through its massive partner network. The interesting thing is that many other companies make money through advertising on the web, but none have managed to succeed in the same way that Google has.
A Typical Business Model
For example, IAC Interactive has built its business around subscription web sites and advertising. Its businesses include Match.com, Citysearch, CollegeHumor, and Ask.com, among many others. These sites attract millions and IAC uses that heft to sell advertising across its network of sites.
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It's been a good business for IAC, particularly since it opportunistically buys out of favor companies that it can turn around and up and coming ideas that it can expand. In fact, the top line has been growing nicely of late. With a growing dividend, it is a good option for income investors who wish to have a little exposure to the Internet.
A Lot of Effort
The thing is that IAC spends a lot of time, effort, and money on its content. It has to, that's what it is selling to advertisers. AOL is another example of the same model. Google, on the other hand, is just a toll taker. It isn't building content to attract eyeballs—it lets others do that.
The search giant is using that same business model in the cell phone space. The company gives away its Android OS and, instead, takes a bite out of every app sale transaction. Yes, creating and maintaining the OS is and will always be costly. However, the bigger the user base of phones, the bigger the company's profits.
Interloper or Partner?
Google has a plethora of “partners,” including Samsung and its Galaxy line of phones and tablet computers. It also counts Facebook as a partner. In fact, that company's efforts to adjust the user interface of Android to highlight Facebook's social network was welcomed by Google even though it makes Android less prominent.
Why? Google doesn't care how its OS gets into customers' hands, it just wants users to be on its platform. If Facebook gets customers to use Android based products, all the better.
Similar, but Different
Facebook, for its part, is in a similar situation as IAC and yet has glimmers of Google's model, too. For example, it has to create and maintain an environment that brings customers to its site. With a large customer base, it has two main ways to make money, selling advertising (the IAC model) and letting others piggyback on its platform (the Google model).
Allowing others access to its customers has been a double-edge sword. For example,Zynga built its business by allowing Facebook users to play games. Such games have been a huge success for Facebook, allowing it to charge a toll for every in-game purchase.
A recent partnership with Netflix has the potential to be a similar winner, if Facebook becomes a video sharing and watching hub. Online gambling is another area that could be a big winner. And Facebook only has to sit back and collect the tolls.
However, it has had a much larger problem giving advertisers access to its customers. Facebook users have been very particular about how their private information gets used. Since the site is basically a way to keep socially connected, it's not surprising that users don't want their private lives exposed to the world at large.
Interestingly, Facebook shares have languished since their public offering despite the service's continued popularity. While it could turn into just another web has been if it can't transition to a mobile world, intrepid investors might be interested in the profit potential of its Google-like qualities.
Google has nailed its business model and looks to have years of success ahead of it. The shares, however, are pretty expensive. That's not surprising for an industry giant that is seemingly hitting on all cylinders. However, for momentum accounts, Schmidt's expectation that two billion phones is just a year or two away suggests that there's still upside potential.