The Freight Train That Is Android

Posted on March 24, 2011. Filed under: android, Internet, iphone, Mobile, Uncategorized, Web/Tech | Tags: , |

[Follow Me on Twitter]

“People get ready, there’s a train a comin’”
– The Impressions

From Zacks via Yahoo: Mark Vickery, On Thursday March 24, 2011, 4:58 pm EDT “BlackBerry maker Research In Motion (NasdaqGS: RIMM – News) beat its fiscal 4Q EPS estimates by 2 cents per share, but missed slightly on quarterly revenues and offered guidance well below the current consensus. This has sent RIMM shares down nearly 10% in after-market trading…”

Yesterday, after the market closed, Research in Motion, the makers of the Blackberry device, announced that they would be lowering their current quarter earnings due to lower average sales prices. In a separate announcement, the company proffered that their new tablet will support Android apps, yet the CEO also made it clear that he believes the world is overly focused on the criticality of having a large numbers of applications on your platform. They also suggested that the guidance issue is temporary, and relates mainly to a product cycle not a systematic change in the industry.

Despite all that has been written about Android, as well as its unquestionable early success, the world at large still doesn’t fully appreciate the raw power of this juggernaut. I have written about this in the past in Android or iPhone? Wrong Question, and Google Redefines Disruption: The “Less Than Free” Business Model. But even so, the more I see, the more I wonder if I too may have underestimated the unprecedented market disruption that is Android.

One of Warren Buffet’s most famous quotes is that “In business, I look for economic castles protected by unbreachable ‘moats’.” An “economic castle” is a great business, and the “unbreachable moat” is the strategy or market dynamic that heightens the barriers-to-entry and makes it difficult or ideally impossible to compete with, or gain access to, the economic castle. Here is a great post from the 37signals blog a few years back that walks through several different examples of potential moats.

For Google, the economic castle is clearly the search business, augmented by its amazing AdWords monetization framework. Because of its clear network effect, and amazing price optimization (though the customer bidding process), this machine is a monster. Also, because of its far-reaching usage both on and off of Google,AdWords has a volume advantage as well. Perhaps the most telling map with regards to the location of the castle can be found in Jonathan Rosenberg’s “Meaning of Open” blog post. In this open manifesto, Jonathan opines over and over again that open systems unquestionably result in the very best solutions for end customers. That is with one exception. “In many cases, most notably our search and ads products, opening up the code would not contribute to these goals and would actually hurt users.” As Rodney Dangerfield said in Caddyshack, “It looks good on you, though.”

AdWords is an highly respectable castle, and Google would clearly want to put a “unbreachable moat” around it. Warren himself is on record suggesting that Google’s moat is pretty good already. But where could you extend the moat? What are the potential threats to Google’s castle? Basically, any product that stands between the user and Google and has the potential to distract the choice of search destination is a threat. A great example is Firefox. Like many browsers, Firefox has a search bar built into the upper right corner. This leads to a substantial number of Google searches for which Google pays Firefox a handsome fee. From time to time, this fee must be negotiated, and as a result there are constant rumors that Firefox might chose another search engine, like Bing. Other examples include smart-phones and choices made by carriers and/or handset makers. As an example, a few years back, Verizon set the default search box on Blackberry’s to Bing instead of Google. Despite Warren’s faith in Google’s moat, there are ways to move the needle on search share, or at least hurt the economics by demanding more profit share for distribution.

So here is the kicker. Android, as well as Chrome and Chrome OS for that matter, are not “products” in the classic business sense. They have no plan to become their own “economic castles.” Rather they are very expensive and very aggressive “moats,” funded by the height and magnitude of Google’s castle. Google’s aim is defensive not offensive. They are not trying to make a profit on Android or Chrome. They want to take any layer that lives between themselves and the consumer and make it free (or even less than free). Because these layers are basically software products with no variable costs, this is a very viable defensive strategy. In essence, they are not just building a moat; Google is also scorching the earth for 250 miles around the outside of the castle to ensure no one can approach it. And best I can tell, they are doing a damn good job of it.

Google has organized this defensive play with precision. Carriers and handset makers that use Android are given economics to do so. The Android version of the “AppStore” shares the majority of its economics with the carrier and handset makers. Once again, they are not building a business, they are building a moat (sorry for the repetitiveness, it’s intentional). Because they are “giving away” money to use their product, this creates a rather substantial conundrum for someone trying to extract economic rent for a competitive product in the same market.

This is the part that amazes me the most. I don’t know if a large organized industry has ever faced this fierce a form of competition – someone who is not trying to “win” in the classic sense. They want market share, but they don’t need economics. Imagine if Ford were faced with GM paying people to take Chevrolets? How many would they be able to sell? What if you received $0.10 for every free Pepsi you consumed? Would you still pay $1.50 for a Coke?

The combined market capitalizations of companies that build desktop operating systems, handset operating systems, mapping software (they give this away with Android also!), as well as internal software that helps to differentiate mobile devices is well over $100B, and may be several times that. Yet, there is no economic law that necessitates that these industries remain in their current form. When software was first imagined as a business, it seemed like a miraculous dream. Because the variable costs were zero, you would make near 100% profit on each incremental unit that you sold. Perhaps the resulting counter-force to this is that if someone can afford to build a near equivalent code base, than they can at their option price to marginal cost ($0.00), the very definition of perfect competition.

One might yearn to suggest that there is a market unjust here that should be investigated by some government entity, but let us not forget that the consumer is not harmed here – in fact far from it. The consumer is getting great software at the cheapest price possible. Free. The consumer might be harmed if this activity were prevented. And as we just suggested above, the market is finally driving towards software pricing that represents “perfect competition.”

In Silicon Valley we like to make light of industries that are facing digital disruption such as newspapers, the record industry, and the movie industry, suggesting that their executives “just don’t get it.” Perhaps now we are witnessing the disruption of not just analog businesses, but also formerly interesting digital businesses as well.

John Doerr, once said “The Internet is the greatest legal creation of wealth in history.” Android may be the opposite of that, the greatest legal destruction of wealth in history.

[Follow Me on Twitter]

Read Full Post | Make a Comment ( 285 so far )

Android or iPhone? Wrong Question

Posted on January 5, 2010. Filed under: iphone, Mobile, Uncategorized, Venture Capital, Web/Tech | Tags: , , , , , |

[Follow Me on Twitter]

In a recent New York Times article, Kathryn Huberty, a Morgan Stanley analyst was quoted suggesting that Apple’s iPhone is the key catalyst for an important new technology trend. “Applications make the smartphone trend a revolutionary trend – one we haven’t seen in consumer technology for many years.” This argument rings true in that the “after iPhone” smartphone market is dramatically more interesting than the “pre-iPhone” smartphone market. Later, Ms. Huberty made an even bolder statement, “The iPhone is something different. It’s changing our behavior…The game that Apple is playing is to become the Microsoft of the smartphone market.”  Or perhaps not.

Many analysts and bloggers have worked hard to position “iPhone vs. Android” as the title fight of the decade in the technology industry. It is an easy comparison to want to make. Both phones use rich microprocessors, are graphical, both have GPS and Wifi. They both run a sophisticated operating system, and they both give you access to thousands and thousands of third party applications. In most practical ways, they seem similar. However, there is one fundamental difference – business model choice.

When Apple launched the iPhone, it was able to secure an unprecedentedly strong business relationship with AT&T. Not only did Apple want control over the user interface, something carriers had been extremely reluctant to cede, it also wanted previously unrealized economics for a handset or OS designer. Apple insisted on upfront revenue dollars as well as a cut of the cellular service stream. AT&T, desperate for a win vs. Verizon, acquiesced.  The product was launched to rave reviews from analysts and consumers alike. It really was a brand new market and a brand new product. As noted earlier, we only “thought” we had seen smartphones before the iPhone. This market, as Ms. Huberty notes, looks like one that is Apple’s to lose.

With the iPhone’s massive success, it would be hard in retrospect to challenge the thinking behind Apple’s business model choice. After all, it will always be true that Apple was the company that “cracked open” the famed Walled Garden of carrier-land. They also did it with style, demanding golden economics as it disrupted a previously obstinate industry. And although AT&T may have become “comfortable” with its choices as a result of the iPhone’s success, other carriers suddenly had an “iPhone problem.” Enter Google.

If Apple’s business model is aggressive relative to the carriers, in contrast Google’s seems unrealistically accommodating. You want to control the user interface? No problem. Want access to the code? We’ll make it open source. What kind of economics do we want? Nothing at all.  What the hell, we will pay you!  That’s right.  Google will give the carrier ad splits that result from implementing the Google search box on any Android phone. FBR Capital Markets suggests that Google is taking this idea one step further in its November 24, 2009 report titled Implications of a Potential Share Shift to Android-Based Wireless Devices. “Recent support for Android-based devices appears to be correlated with significant up-front financial incventives paid by Google to both carriuer and handset vendors.” FBR goes on to suggest that these incentives may be as high as $25-50 per device. This is simply an offer that no carrier can refuse, particularly when U.S. carriers are currently in the habit of paying $50-150 per handset sold in subsidies.

While Apple may have opened the proverbial Walled Garden, it is Google, with its aggressive Android offering, that aims to obliterate it. Make no mistake about it; Apple was the pioneer with the amazing revolutionary product. Also, with no iPhone, there is no Android. This is not to say that Android copied iPhone, but rather the impetus to adopt and trust Google’s Android offering was driven by a market dynamic that resulted directly from the iPhone’s success.  Without the iPhone, it is possible that most carriers might have opted not to use Google’s OS solely for the reason that letting a powerful company like Google in the front door can be a risky strategic bet.

All of this is now history. The iPhone does exist, and it is wildly popular. There are an estimated 55 million iPhones in use around the world. Despite this remarkable success, history will also show that Apple intentionally chose a business model with plenty of room for disruption underneath its pricing structure. It also chose a single carrier as a partner, which resultantly threatened others. Then Google built a product and a strategy that allayed the carrier’s relative fears. Google gave them what they wanted, and then even gave them money. It could afford to do this because Google aims solely to protect the great business they already have in advertising, not to make money directly from the product (HW or SW in this case). Microsoft Windows, Internet Explorer, and Mozilla’s Firefox represent choke points on the personal computer whereby Google could lose search share, or at least be forced to pay a toll. In mobile, they see a chance to potentially eliminate the toll-takers.

With a business model that allows for much broader distribution and price points that are well beneath the iPhone, Google’s Android won’t compete directly with the iPhone.  For the iPhone loyalist, like Stewart Alsop who railed against Android, Android is simply not an option.  This price insensitive user demands the very best experience they can possibly have and this is still the iPhone. Users won’t switch in mass from the iPhone to the Android. It’s the other 3.95 billion cell phone users that are highly likely to consider Android a step up from their current feature phone. The Android strategy results in phones at much lower prices with much more diversity which will hit a braoder set of demographics. Apple can and will quintuple its current market share and still have a small portion of the overall cell phone market.

This is why the two products do not compete head to head. With its super aggressive model, Android will be the choice of the masses, and with its sleek design and non-compromising price point, Apple will rule the high end. Many have suggested that Apple is perfectly happy with its high-margin spot at the top of the food chain. They are doing exceptionally well with that position in the personal computer market – in fact, they are currently gaining share at an accelerating pace. So no need to worry about Apple, they are doing just fine (as their stock price suggests). They are just not currently executing a model to become the “Microsoft” of the smartphone market.

Some will argue that the best product will win the market and that Apple will still dominate the smartphone market. The history of the personal computer market is no omen for this thesis. If you think about it, the people that know this better than anyone are the exact Apple loyalists who have been frustrated for years at Apple’s lack of dominance in the PC market. Disruptive business strategies can and have trumped better products. And with no change to the current market, the Android leveraged position in the market could result in staggering unit share gains. This is not to say that the Google Android is better than or as good as the Apple iPhone. The key point is that it does not have to be. It only needs to be dramatically better than the current feature phone. Which it is.

While Apple will be fine as Android gains steam, the amount of shrapnel flying around this new marketplace is immense, so expect innocent bystanders to be compromised.  Recognize that as Google’s play here is as much defense as offense, they have less of a need to “make a profit,” at least right out of the gate.  This type of attitude always makes for a messy competitor.  Also, because of the sheer breadth of the effort in terms of number of handset makers and number of carriers, Android will be marketed extremely aggressively.  Lastly, the early application leaders are beginning to believe it’s a two horse race.  Currently the iPhone is priority number one.  That said, increasingly these application vendors are seeing Android as the primary second platform to support.  Others are falling further and further behind.

Also, Android doesn’t appear to be an OS that stops at the smartphone market.  Expect much experimentation with a variety of hardware manufactures and almost any and every embedded device market from navigation devices to e-readers to tablets and beyond.  Android gives every Korean, Taiwanese, and Chinese manufacture whoever wanted to approach these markets a huge head-start.  Additionally, the more of these vendors that build on Android, the more Android will evolve for the better.  The number of applications will increase, and the problems will get worked out.  Just like Microsoft worked its way from Windows to Windows 3 and eventually to Windows 7, Android will improve with time as well.

With its disruptive and leveraged strategy, it is Google that is attempting to be the Microsoft of the smartphone market.  Perhaps ironically, Apple is well positioned to be the “Apple” of the smartphone market.

[Follow Me on Twitter]

Read Full Post | Make a Comment ( 154 so far )

Google Redefines Disruption: The “Less Than Free” Business Model

Posted on October 29, 2009. Filed under: Internet, Uncategorized, Venture Capital, Web/Tech | Tags: , , , , , , , , |

[Follow Me on Twitter]

I like to think of myself as an aficionado of business disruption. After all, as a venture capitalist it is imperative to understand ways in which a smaller private company can gain the upper hand on a large incumbent. One of the most successful ways to do this is to change the rules of the game in such a way that the incumbent would need to abandon or destroy its core business in order to lay chase to your strategy. This thinking, which was eloquently chronicled in Clay Christiansen’s The Innovator’s Delimma, is the key premise behind recently successful business movements like SAAS (Software as a Service), open source software, and the much-discussed Freemium Internet model.  And while each of these disruptions are impressive in their own right, when I read this week that Google was including free turn-by-turn navigation directions with each and every Android mobile OS, I had an immediate feeling that I was witnessing a disruptive play of a magnitude heretofore unseen.

google_maps_logoGoogle has long had an interest in maps. Early in its history, the company added “Maps” as one of the coveted tab alternatives offered at the top of the screen above its famed search box. At that time, Google did what many others did to enter the mapping business – they licensed data from the two duopolists that ruled the mapping business – Tele Atlas and NavTeq. Over the years, as these two companies gained more and more power, and larger and larger market capitalizations, Google’s ambitions were growing too. Google wanted to spread its maps across the web, and to allow others to build on top of its mapping API.  The duopolists, recognizing a fox in the henhouse, were apprehensive to allow such activity.

Logo NAVTEQIn the summer of 2007, excitement regarding the criticality of map data (specifically turn-by-turn navigation data) reached a fever pitch.  On July 23, 2007, TomTom, the leading portable GPS device maker, agreed to buy Tele Atlas for US$2.7 billion. Shortly thereafter, on October 1, Nokia agreed to buy NavTeq for a cool US$8.1 billion. Meanwhile Google was still evolving its strategy and no longer wanted to be limited by the terms of its two contracts. As such, they informed Tele Atlas and NavTeq that they wanted to modify their license terms to allow more liberty with respect to syndication and proliferation. NavTeq balked, and in September of 2008 Google quietly dropped NavTeq, moving to just one partner for its core mapping data. Tele Atlas eventually agreed to the term modifications, but perhaps they should have sensed something bigger at play.

teleatlasRumors abound about just how many cars Google has on the roads building it own turn-by-turn mapping data as well as its unique “Google Streetview” database. Whatever it is, it must be huge. This October 13th, just over one year after dropping NavTeq, the other shoe dropped as well. Google disconnected from Tele Atlas and began to offer maps that were free and clear of either license. These maps are based on a combination of their own data as well as freely available data. Two weeks after this, Google announces free turn-by-turn directions for all Android phones. This couldn’t have been a great day for the deal teams that worked on the respective Tele Atlas and NavTeq acquisitions.

To understand just how disruptive this is to the GPS data market, you must first understand that “turn-by-turn” data was the lynchpin that held the duopoly together. Anyone could get map data (there are many free sources), but turn-by-turn data was remarkably expensive to build and maintain. As a result, no one could really duplicate it. The duopolists had price leverage and demanded remarkably high royalties, and the GPS device makers (TomTom, Garmin, Nokia) were forced to be price takers. You can see evidence of this price umbrella in the uniquely high $99.99 price point TomTom now charges for its iPhone application. When TomTom bought Tele Atlas, the die was cast.  Eat or be eaten. If you didn’t control your own data, how could you compete in the GPS market?  This is what prompted the Nokia-NavTeq deal.

garmin_stockGoogle’s free navigation feature announcement dealt a crushing blow to the GPS stocks. Garmin fell 16%. TomTom fell 21%. Imagine trying to maintain high royalty rates against this strategic move by Google. Android is not only a phone OS, it’s a CE OS. If Ford or BMW want to build an in-dash Android GPS, guess what? Google will give it to them for free. As we noted in our take on the free business model, “if a disruptive competitor can offer a product or service similar to yours for ‘free,’ and if they can make enough money to keep the lights on, then you likely have a problem.” It would be one thing if this were merely a mean-spirited play by Google to put an end to the GPS data duopoly. But it is not. There are multiple facets to this remarkably disruptive move.

While it is obvious that this maneuver creates a problem for the multi-billion dollar GPS market, it also poses real challenges for the leading smart phone players – RIM’s Blackberry and Apple’s iPhone. Without access to their own mapping data, these vendors now face an interesting dilemma. Do you risk flying naked without free navigation or do you suck it up and swallow the above average royalty fee for each and every handset? Neither option is stellar. This problem isn’t nearly as daunting as the one now faced by the Windows Mobile and Symbian teams.  As software providers, they are lucky to get a per unit royalty equal to that extracted by the GPS data guys. If they are now forced to integrate this data merely to keep their product competitive, their gross margin just went negative. Ouch!

This is not just incredible defense. Google is apt to believe that the geographic taxonomy is a wonderful skeleton for a geo-based ad network.  If your maps are distributed everywhere on the Internet and in every mobile device, you control that framework. Cash starved startups, building interesting and innovative mobile apps, will undoubtedly build on Google’s map API.  It’s rich, it is easy to use, and quite frankly the price is right. In the future, if you want to advertise your local business to people with an interest in your local market, chances are you will look to Google for that access.

Introducing the “Less Than Free” Business Model

android logoGoogle’s brilliance doesn’t stop there. It is hard not to have been surprised by the rapid rise in recent buzz surrounding the Google Android Smartphone OS. When I asked a mobile industry veteran why carriers were so willing to dance with Google, a company they once feared, he suggested that Google was the “lesser of two evils.” With Blackberry and iPhone grabbing more and more subs, the carriers were losing control of the customer UI, which undoubtedly represents power and future monetization opportunities. With Android, carriers could re-claim their customer “deck.” Additionally, because Google has created an open source version of Android, carriers believe they have an “out” if they part ways with Google in the future.

I then asked my friend, “so why would they ever use the Google (non open source) license version.”  (EDIT: One of the commenters below pointed out that all Android is open source, and the Google apps pack, including the GPS, is licensed on top.  Doesn’t change the argument, but wanted the correct data included here.)  Here was the big punch line – because Google will give you ad splits on search if you use that version!  That’s right; Google will pay you to use their mobile OS. I like to call this the “less than free” business model. This is a remarkable card to play. Because of its dominance in search, Google has ad rates that blow away the competition. To compete at an equally “less than free” price point, Symbian or windows mobile would need to subsidize. Double ouch!!

lessthanfree“Less than free” may not stop with the mobile phone. Google’s CEO Eric Schmidt has been quite outspoken about his support for the Google Chrome OS. And there is no reason to believe that the “less than free” business model will not be used here as well. If Sony or HP or Dell builds a netbook based on Chrome OS, they will make money on every search each user initiates. Google, eager to protect its search share and market volume, will gladly pay the ad splits. Microsoft, who was already forced to lower Windows netbook pricing to fend off Linux, will be dancing with a business model inversion of epic proportion – from “you pay me” to “I pay you.”  It’s really hard to build a compensation package for your sales team on those economics.

Naysayers of these assertions will likely have the same retort – quality is key. They will argue that Google’s turn-by-turn apps are inferior to their well honed market leading products. With regard to Android, Google will lack the user interface or embedded software expertise necessary and will deliver a subpar product.  Plus, because the Android OS will be so splintered, QA testing will be difficult and incompatibility issues will abound. In the short run, these issues will exist.

Despite these challenges, it would be a dangerous strategy for any of the many threatened players in these markets to hang on to this “quality” rationalization for very long. First, Google’s products will get better over time. The sheer volume of the Android phones in the market will give them new data feeds to complement their own mapping effort. Also, they can create UGC hooks for users to embellish their own maps (like in Google Earth), offering themselves further differentiation.  With regard to Android, version 3 will be better than version 2 will be better than version 1.  Microsoft knows this game well.

Another perhaps even more important factor is that when a product is completely free, consumer expectations are low and consumer patience is high. Customers seem to really like free as a price point. I suspect they will love “less than free.”

[Follow Me on Twitter]

Read Full Post | Make a Comment ( 403 so far )

    About

    …focusing on the evolution and economics of high technology business and strategy. By day, I am a venture capitalist at Benchmark Capital.

    RSS

    Subscribe Via RSS

    • Subscribe with Bloglines
    • Add your feed to Newsburst from CNET News.com
    • Subscribe in Google Reader
    • Add to My Yahoo!
    • Subscribe in NewsGator Online
    • The latest comments to all posts in RSS

    Meta

Liked it here?
Why not try sites on the blogroll...