AAPL Apple Inc

By Douglas MacMillan and Liza Lin 

In February, a Google executive appeared at a tech conference in Barcelona touting a new, low-cost smartphone outfitted with a custom version of its popular mobile operating system.

Less than two months later, that phone's future is in doubt. The U.S. has barred the device's manufacturer, Chinese firm ZTE Corp., from working with American companies, meaning the specially made Android software that powers the phone is off limits.

The government intervention highlights an unforeseen challenge for Google in a bid to get its mobile software in the hands of wider swaths of users. Google, a unit of Alphabet Inc., is relying on several Chinese companies to distribute its Android apps to millions of less-affluent smartphone users, even as rising trade tensions between China and the U.S. are making those partnerships more risky.

Spokespeople for Google and ZTE declined to comment.

Partners like ZTE are increasingly important to Google as it competes with Apple Inc. and Samsung Electronics Co. for users of mobile services. Google's Android operating system runs on more than 80% of smartphones world-wide, but the company doesn't charge anything for the operating system. Instead, it makes money from licensing fees and ads running on Android apps and sales from its app store, while collecting valuable user data.

Google struggles to reach users of Apple phones, which run the iOS operating system and come preloaded with apps, and faces more competition from Samsung, the world's largest seller of Android devices, which equips phones with its own versions of communication and productivity apps.

Google also derives little value from Android phones in China, despite representing 86% of smartphones shipped there last year, according to researcher Canalys. Google's services have been banned in the country since the search giant exited China over concerns of censorship in 2010; phone makers there run apps made by Chinese tech giants Baidu Inc. and Tencent Holdings Ltd.

But elsewhere, where Google's apps aren't banned, Android is essential to the internet giant, especially on lower-cost phones. In the U.S., about one-quarter of U.S. customers pay less than $100 for smartphones, according to Neil Shah, an analyst with research firm Counterpoint.

Morgan Stanley estimates Alphabet's revenue from mobile-search ads and a cut of sales from apps sold in the Google Play store was about $33.8 billion last year, or about 30% of the company's overall revenue.

ZTE was the first company to carry the "Android Go" operating system on a phone built for the U.S. market. The $80 Tempo Go, released on March 30, features new versions of popular mobile apps, like Google Maps and Gmail, designed to load faster and take up less space on cheaper phone models.

Phones bundled with Android Go are offered outside of the U.S. by Chinese phone makers TCL Corp. and Transsion Holdings Ltd. as well as Finland's Nokia Corp. and India's Lava International Ltd. The operating system and suite of Google apps takes up 50% less space than the regular version of Android.

Huawei Technologies Co., a Chinese hardware manufacturer labeled as a national-security threat by the U.S. government, announced it would start selling a phone with Android Go in the near future.

ZTE, the fourth-largest seller of smartphones in the U.S., looked like an inroad to more potential users of Google's mobile services. Remarkably, the Shenzhen-based company almost doubled its share of the U.S. market last year to 11.2%, according to Canalys, by nurturing relationships with mobile carriers, opening five research and development centers in the country and upping its spending on Washington lobbying.

Because Tempo Go has only a fraction of the computing power of a standard smartphone, Google's apps will generally work much better on it than those made other companies. "It gives Google complete control over the phone," Mr. Shah said.

In a statement on Friday, ZTE called the Commerce Department order "unacceptable," saying it will "not only severely impact the survival and development of ZTE, but will also cause damages to all partners of ZTE, including a large number of U.S. companies."

It remains unclear whether the company will continue selling the Tempo Go and other phones featuring Android apps. The U.S. is by far its biggest market, with nearly half of its phones shipped there last year, according to Canalys. It sells other phones outside of China with its MiFavor interface that is powered by Android and uses Google apps.

Analysts say while ZTE may be able to use some version of the Android operating system due to exemptions for open-source software, the company can't include any Google apps on its phones. It would also prevent users from downloading Android software updates, which could put users' privacy and safety at risk, analysts said.

The clash between U.S. and Chinese trade officials could have a grander effect on Google, which shut down its search engine there over the country's censorship rules. Google could have a hard time returning back to the country, said Mo Jia, Shanghai-based research analyst at Canalys.

"Google has always wanted to come back to the Chinese market," he said. "If the trade war continues, both the Chinese technology companies and the American technology companies are at risk."

Write to Douglas MacMillan at douglas.macmillan@wsj.com and Liza Lin at Liza.Lin@wsj.com

(END) Dow Jones Newswires

April 22, 2018 08:14 ET (12:14 GMT)

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