By Rob Copeland and Tim Higgins 

Inside Google, they called the scenario "Code Red," so stark was the prospect of losing the search engine's lucrative pipeline from Apple Inc.'s iPhone.

Now that possibility is officially on the table.

Google's partnership with Apple is at the heart of the U.S. Department of Justice antitrust lawsuit claiming that the Alphabet Inc. unit misused its power in an anticompetitive manner, potentially threatening a major revenue stream for both tech giants

It has long been known that Google relies on search traffic from Apple's popular line of phones. Google's flagship search engine is the preset default on Apple's Safari phone browser, meaning that when consumers enter a term on their phone, they are automatically fed Google search results -- and related advertising.

What's new is just how central it is to both companies, and to the antitrust case. While the government stopped short Tuesday of asking for specific remedies, the prominence of the Apple arrangement in the lawsuit leaves little doubt that the Justice Department will seek to intercede.

The government says that Apple CEO Tim Cook and Google's CEO Sundar Pichai -- neither of whom are named in the lawsuit -- met in 2018 to discuss how the companies could work together to drive search-revenue growth.

Afterward, according to the lawsuit, a senior Apple executive followed up with a Google counterpart with some encouraging words: "Our vision is that we work as if we are one company."

The companies declined to comment on the alleged meeting. The apparent friendliness is a change -- Apple's late co-founder Steve Jobs and former Google Chief Executive Eric Schmidt famously fell out over Google's launch of competing mobile software.

Though Google and Apple have been tight-lipped on how much their deal is worth, the lawsuit projects that it accounts for between 15% and 20% of Apple's annual profits.

That means Google pays as much as $11 billion, or roughly one-third of Alphabet's annual profits, to Apple for pole position on the iPhone. In return, Apple-originated search traffic adds up to half of Google search volume, the government says. Google declined to comment on that statistic, and representatives said they weren't aware of the "Code Red" language included in the lawsuit.

Google said it plans to challenge the lawsuit, and the litigation is expected to drag on for years.

"This lawsuit would do nothing to help consumers," said Kent Walker, Google's chief legal officer, in a blog post. "To the contrary, it would artificially prop up lower-quality search alternatives, raise phone prices, and make it harder for people to get the search services they want to use."

On the Apple partnership he said it was "no different from the agreements that many other companies have traditionally used to distribute software."

The threat to the arrangement between Apple and Google didn't spook investors. Shares in both companies climbed about 2% on Tuesday after the lawsuit was filed, beating the broader market, as they have done most of the year.

Securing the prime piece of real estate in the Apple ecosystem has had the effect of denying competitors the ability to compete, the government alleged. "Google has almost completely shut out its competitors from mobile distribution," the lawsuit said.

The inclusion of Apple in the government lawsuit follows a House subcommittee report that examined Big Tech's anticompetitive practices that claimed Apple, too, was misusing its power it holds over its iPhone ecosystem, hurting rivals and benefiting itself. Apple disputed the report.

Scrutiny of the business arrangement comes as Mr. Cook has been trying to build out the company's services business as revenue from its iPhones, which make up about half of its sales, have stagnated after falling from a peak two years ago.

The scope of the deal has long been a mystery among analysts. In June, Toni Sacconaghi, an analyst for Bernstein, estimated Google pays Apple as much as $8 billion annually to be the default search engine for its mobile operating system and Siri, a voice assistant. Other analysts have pegged it as higher, closer to the figures cited in the government lawsuit.

Mr. Sacconaghi suggested in a note to investors that Google was motivated to spend the money in part to block rival Microsoft Corp.'s Bing search engine from gaining a foothold. "Is Google really willing to risk a resurgence of Bing to save a few billion dollars?" he asked.

Bing currently holds about 7% of the search market, compared with 88% for Google, the lawsuit says, citing public data sources.

The government alleged in the lawsuit that Google also took steps to freeze out competition in phones that run its Android software, which account for 40% of mobile device usage. Unlike Apple's operating system, Android can be licensed by third-party device manufacturers, but the lawsuit alleges that Google steers those companies to make its search engine the default through strict contractual agreements and other measures.

The lawsuit notes that getting the default position on phones is critical because most users never change the setting after their purchase.

"On Android devices, we have promotional agreements with carriers and device makers to feature Google services," Mr. Walker of Google said in the blog post. "These agreements enable us to distribute Android for free, so they directly reduce the price that people pay for phones."

Write to Rob Copeland at rob.copeland@wsj.com and Tim Higgins at Tim.Higgins@WSJ.com

 

(END) Dow Jones Newswires

October 20, 2020 16:04 ET (20:04 GMT)

Copyright (c) 2020 Dow Jones & Company, Inc.
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