Considering industry trends and all the different projects in which Google Inc (NASDAQ:GOOG) is currently involved, it would be no surprise at all to see profit margins for the company falling over the next quarters, and this may create some uncertainties for investors in the middle term. On a long-term perspective, however, the company offers astounding growth prospects.
It’s no secret at all that online traffic is shifting towards mobile devices, and mobile ads tend to be cheaper that traditional desktop advertising. Google is remarkably well positioned for the mobile revolution; and online advertising is a high-growth industry, so the company should be able to sustainits pricing power in the long term. In the first stages of the transition towards mobile, however, Google could see lower profitability.
Android has a market share above 70% in the global smartphone business and new Android tablets are expected to gain market participation too. Besides, when it comes to Apple Inc. (NASDAQ:AAPL) products, Google Inc (NASDAQ:GOOG) has been smart in making sure that its apps and services are well incorporated into iOS.
The company builds fantastic iOS applications: Google Maps, YouTube, Google Earth, Gmail, and Google Chrome are among the most popular applications for iOS. According to some estimates, Google may be paying something in the area of $1 billion annually to Apple for the privilege of being the default search engine in its devices.
This “friendly war” approach to competing against Apple Inc. (NASDAQ:AAPL) has its drawbacks. Since Apple doesn’t share its own apps like Siri, iMessage, iWork, iPhoto and FaceTime with other companies, the Cupertino giant gets access to both its own exclusive apps and the ones developed by Google Inc (NASDAQ:GOOG), and this is a considerable competitive advantage.
Google, on the other hand, is just positioning itself strategically to profit from mobile advertising, no matter which manufacturer wins the war for smartphones and tablets.
In the second half of 2013 Google is expected to launch its Google X phone manufactured by its Motorola subsidiary, and a new version of its Nexus 7 tablet is also expected around July of this year. Hardware is a low-margin business, and most analysts believe that Google will continue focusing on competitively low prices in order to achieve market share gains at the expense of profitability.
These moves are decidedly targeted at strengthening its competitive position in mobile. Amazon.com, Inc. (NASDAQ:AMZN) has been quite successful in the low-end segment of the tablets market with its Kindle Fire products. Although the Kindle works with Android, it’s a modified version of the operating system, which blocks access to Google Inc (NASDAQ:GOOG)’s ecosystem.
Amazon’s forked version of the operating system is a serious inconvenient for Google, and according to the Wall Street Journal the company is feeling anxious about its dependency on Samsung too:
Several people familiar with the relationship between the companies said Google fears that Samsung will demand a greater share of the online-advertising revenue that Google generates from its Web-search engine.
Google’s foray into hardware is probably not intended to make plenty of money from the sale devices, but as a move to strengthen its competitive position in mobile by making sure that it doesn’t depend too much on other companies. This may be a smart strategy, but also a drag on profitability in the middle term.
Google Inc (NASDAQ:GOOG) has plenty of exciting projects in its pipeline, targeted both at consolidating its position in online advertising and at expanding into new business areas. After announcing the expansion of Google Fiber to Austin, Texas, a few days ago, the company has also confirmed its foray into Provo, Utah. This has the potential to be a truly disruptive service, but it has enormous startup costs related to infrastructure development. Due to the economics of the business, Google Fiber won’t be profitable for a long time.
Other projects like Google Glass or the self-driving car have little commercial visibility in the middle term, although they certainly have the potential to become successful technologies with unlimited possibilities over the next years. These are just two noteworthy examples; Google is working on several different products and technologies of this kind, and they are likely to generate higher costs before they can be transformed into profitable businesses.
None of this means that Google is doing the wrong thing; on the contrary, investing the big and growing cash flows from online advertising into innovative projects to consolidate its competitive strength and expand into businesses with attractive long-term potential is precisely what the company should be doing.
Projects like Android, YouTube and Chrome among others seemed like a waste of time and money before they became remarkable strategic moves, so management has proven that it knows how to read the relevant trends in the industry and apply a long-term vision to the company’s strategy. Larry Page and his team deserve the benefit of the doubt when it comes to making investments with a long-term focus.
Due to the mobile boom and all the new ventures in which Google Inc (NASDAQ:GOOG) is involved, falling profit margins over the next quarters looks like a distinct possibility. Whether investors will give it the Amazon treatment — buying because of a focus on long-term growth prospects — or if Google will be treated like Apple and sold because of fear and uncertainty over falling profitability remains to be seen.
One thing looks clear to me though — the company is doing the right thing by investing for the future, so any short-term margin pressure would be no reason to sell the stock.
The article Google: Short-Term Concerns and Long-Term Opportunities originally appeared on Fool.com and is written by Andrés Cardenal.
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