Tue, Dec 15, 09
Observing Microsoft’s dilemma against the iPod/iTunes juggernaut a few years ago, Steve Jobs offered this prediction:
The problem is, the PC model doesn’t work in the consumer electronics industry, where you’ve got all these companies and some does one thing and another does another thing. It just doesn’t work. What’s going to happen is that Microsoft is going to have to get into the hardware business of making MP3 players. This year. X-player, or whatever.
Soon Microsoft did get into the hardware business by introducing its own Zune player coupled with its un-licensed PlaysForSure platform, thereby leaving its erstwhile manufacturing partners high and dry. The anti-Apple digital music camp hasn’t recovered since.
Just as Microsoft leveraged its enormous pile of cash from Windows/Office monopoly to reach into other domains, so did Google with its huge revenue base in search/advertising. In just a few years, Google has put together a breathtaking spread of products that go far beyond search and encroach the Microsoft empire in every possible way, including an OS and business productivity apps:
Microsoft made its money in software. Its forays into hardware have been far more troublesome: its PC peripherals business has been profitable but non-strategic, Xbox a financial drain since its inception, Ultra-Mobile PC and Surface most forgettable, and Zune an unmitigated disaster.
Unlike Microsoft, Google had shied away from hardware until now (except for its lackluster enterprise search appliance). But with the circulating news about its Nexus One smartphone, Google may have decided to complete its ongoing emulation of its archenemy. So let’s assume, as an exercise, that Google will soon sell a branded smartphone direct to consumers. What might its business model be?
Microsoft has been the flag bearer of the “one OS, many hardware manufacturers” approach to product design. While keeping Windows APIs proprietary, Microsoft broadly licensed its OS, thereby fueling the growth of the global PC market. However, as Microsoft’s share of the PC industry profits grew, manufacturers witnessed the commoditization of their hardware in a cut-throat race to differentiate on price.
The failed ‘PC model’
Tied to commodity sales and thus slim profits, PC manufacturers failed to build competencies in hardware and systems innovation. So much so that even the perennially incompetent Microsoft management realized the futility of “one OS, many hardware manufacturers” approach (as we underscored previously) in an internal memo from Steve Ballmer:
In the competition between PCs and Macs, we outsell Apple 30-to-1. But there is no doubt that Apple is thriving. Why? Because they are good at providing an experience that is narrow but complete, while our commitment to choice often comes with some compromises to the end-to-end experience. Today, we’re changing the way we work with hardware vendors to ensure that we can provide complete experiences with absolutely no compromises. We’ll do the same with phones—providing choice as we work to create great end-to-end experiences.
If Microsoft learned from the success of iPod and iPhone the centrality of “end-to-end user experience” in consumer products, it looks like Google has learned from Microsoft the perils of letting others own the customer behavior around its revenue base. Mobile search, for example, may have grown some 30% recently, but I’m sure Google has also recognized that 125,000 iPhone apps represent an emerging consumer behavior which obviates traditional browser-based navigation and search in favor of domain specific apps that access data and information in much faster and easier ways. Why go to a web browser, type a search term like it was the 1990s and wade through pages of search results, when you can click a button or flick a gesture to get an efficient answer with a dedicated app? Why suffer through Google-supplied ads when a native app costs next to nothing on the iPhone?
So while the market is still relatively nascent, it looks like Google has decided to do what Microsoft couldn’t successfully pull off: Apple-style vertical integration of hardware, OS, apps and services…direct to customer.
Will Google succeed where Microsoft failed?
Google will have to address a few questions:
• Hardware — Apple, General Magic, WebTV and Danger alumni and current Google VP of Mobile Platforms, Andy (“We’re not making hardware”) Rubin does have hardware experience, Google as a company doesn’t.
- So how much of design and production will Google have to outsource if it’s to release multiple devices over time?
- Will it rely on a contract-level partner, like Apple does with Foxconn, or will it hand over greater design responsibility to an established handset manufacturer like HTC, or let multiple manufacturers build different models?
- Will it have time to organically expand its industrial design competencies or be forced to acquire a design outfit or raid a talent pool like the Palm or Motorola smartphone teams?
• Marketing — Google has terrific global brand recognition among consumers. However, it has no (non-ad) sales force, physical store outlets or consumer electronics retailing experience. It may choose to sell the Nexus solely through an online store or in cooperation with a carrier partner like T-Mobile. Unfortunately, unlocked and unsubsidized smartphone sales in the U.S. has been fairly disastrous. Ask Nokia and Sony. Consumer retail advertising and marketing is nuanced and hard to get right. Ask RIM and Palm.
- Where will Google get sufficient marketing and merchandising experience to compete against Apple?
- What incentives will there be for its retail partners that competitors can’t match?
• Marketshare — By the time Nexus is sold, it’s likely for Apple to announce an iPhone/iPod touch userbase of 60-70 million. That’s the most profitable segment of the industry with a demonstrated history of purchasing behavior and billions of dollars of investment in devices, peripherals, content, apps and other sticky aspects of the Apple ecosystem. Unless Apple falls behind spectacularly, Google or any other manufacturer will find it extremely difficult to convert those users to their own platform. Ask Palm.
- Will Google go after Apple’s lucrative consumer base, remain wedged between Apple and RIM or be content to harvest newcomers to the smartphone sector? Will the latter be large and profitable enough?
- They didn’t with the other Android phones, so why would developers first and users later switch from a 60 million strong well-oiled ecosystem to another one starting from scratch?
- How will Google demonstrate to developers that it can actually deliver a userbase not just as large as Apple’s but also with comparable purchasing power and history of spending money?
- If Google’s after Microsoft Windows Mobile users as it’s often claimed, why would it need to release its own phone?
• Partners — Music labels complain about Apple having too much power and print publishers look for alternatives to Amazon’s dominance.
- Why would phone manufacturers and carriers want to adopt the Android platform if its founder and chief driver is directly competing against them, with a first-and-best implementation strategy?
- If Nexus is made by HTC, how happy can other manufacturers be?
- We don’t have a single significant case of a platform licensor successfully competing against its own licensees. Can Google create a precedent for such an unlikely arrangement?
- What will Google do if Microsoft approaches spurned Android partners or those on the fence with improved Win 7 plus financial incentives minus the threat of competition?
• Fragmentation — With Chrome/WebKit browsers and Chrome/Android OSes Google has certainly presented a confusing platform strategy.
- If Nexus runs on open-source Android, what makes it so superior to other Android phones?
- If it’s the UI, why wouldn’t all or most of the enticing parts of it be copied by others?
- If it’s the tightly integrated Google apps/services, wouldn’t Google be seen as favoring itself at the expense of its own developers?
- If it’s the hardware, where did Google get such expertise and how long could it keep such differentiation?
- If proprietary Google apps/services dominate Nexus, will it still be seen as ‘open’ by developers?
- If Nexus is so different to be so attractive, wouldn’t it by definition further stratify the Android platform into an incompatibility mess for developers?
• Focus — One of the principal factors in Microsoft’s decline has been its incessant search for the next profitable market, however far afield it may be from its core competencies. Google has its own share of moribund products, like Orkut, Google Checkout, Google Base, Knol, Google Answers, Google Catalogs, Jaiku, Dodgeball, etc. Nothing is wrong with experimentation, of course, but such fast paced diversification always brings a measure of dispersion of top-level management focus. People have already started complaining about deterioration of Google’s core search competency. Given the growth of non-algorithmic, social network derived way-finding, it’s not impossible for Google to be blindsided by peripheral attacks to its own core business.
- Does Google have a management team and sufficient corporate focus to sustain a profitable direct-to-consumer hardware merchandising strategy?
- If profit is not the primary driver of Nexus and it comes to be perceived as a loss leader to Google’s search/ad business, will developers and other third parties take the risk of devoting resources to it?
• Financials — In terms of impact to its bottom line, Nexus may be Google’s biggest bet yet on its brand equity. If Nexus doesn’t do well, a 20% trim to its marketcap would not be unthinkable.
- In order to deny market dominance to Sony, Microsoft poured cash into Xbox development for years, having little to show for it in profits. Will Google be a better smartphone manufacturer and retailer than Microsoft was with Xbox?
- Apple has very shrewdly used its market share, cash, as well as inventory management and component pricing knowledge from selling iPods to both lower its production costs and deny comparable advantages to its iPhone competitors. Does Google have institutional expertise to match that?
- Is Google planning to subsidize Nexus sales with hard cash or ad revenue shares to gain marketshare? For how long and at what risk to its balance sheet?
- If Nexus falls short, will Google’s top management and share price be punished for having lost perhaps its greatest asset, the aura of invincibility?
An unlikely Christmas gift?
During its growth period, Microsoft entered into one risky bet after another, from cable TV to office equipment automation to Dick Tracy watches. It saw threats to its core revenue base from every new development, every new player to come along. And expand and spend it did. It did, mostly because its management thought it could.
Of course, Google doesn’t think it’s Microsoft and could surprise everyone with a brilliant plan to bypass these hurdles. Or by alienating its own partners and further fragmenting its Android platform, it could inadvertently resuscitate Microsoft’s mobile business as an alternative, if the lights are still on in Redmond.