Does it not strike everyone as odd that a company whose business is in the cloud also needs to peddle systems software...even devices?
It's like a philosopher at a conference trying to convince the audience of his idea requiring that they use a certain type of pencil to take notes. And only he can give you that pencil.
This should lead to serious questions: Firstly, maybe you don't need to take notes, secondly perhaps you don't use a pencil and thirdly why his pencil?
Analogously: Firstly, Google services don't need specific devices to be used because they're designed around web standards. Secondly, they don't need specific client software or APIs either and, thirdly, they certainly should not need specific systems software. Like the philosopher, Google does not charge for their pencil, but that's beside the point.
You can only conclude that either the philosopher's is a scoundrel or his idea is not that good.
I've been asked in comments on this blog who will win the "mobile war".
I use two analytical tools to answer this question: (1) history (2) value chain analysis.
History shows that operators are very important and hence very powerful in this market. That makes sense on many levels. They control what phones you get to buy, they decide the pricing and they decide frequently how you can use the phone. This is because the networks are expensive to build and maintain and there is an implicit bargain struck that the user and device should conform to the operator.
Value chain analysis tells me that as networks are not good enough, tight integration of the business models of the phone vendors and the operators is necessary to climb up the trajectory toward good enough as quickly as possible.
Therefore, given the distribution of value/bargaining power in the chain, it’s reasonable to assume that it’s operators who will decide which platforms win/lose and to what degree.
That simply means that no single platform can win a disproportionate share because it would threaten the balance of control the operators require. So talk of “dominance” of one platform or another is hyperbole. The most likely scenario is an even distribution of share between 4 or 5 competitors, so I expect iPhone and Android to get 20% share each.
This is not “fair” or economical or efficient, but it’s the way it’s going to be for a long time. If you're a fan, don't despair. In a few years, it still means hundreds of millions of units a year for each platform.
If you want to dream or hope for a more efficient outcome, you’ll have to look outside the cellular network model. I.e. think how iPod/iPad and Android tablets will evolve into communications products.
I did not include all vendors for various good reasons. The first survey (market share) did include an "others" category that made the volume data complete, but in the financial data sets, I chose to include the top 7 vendors that make up 80% of device volumes.
One noteworthy vendor that was not included was HTC. HTC is an important vendor for several reasons:
it's a pioneer in smartphones having made the first Windows Mobile devices and the first Android devices
at one point it sold 80% of all Windows Mobile devices
even if it did not brand its devices, it was the name behind many re-branded or white-label operator branded phones
it has a brand of its own today and is expanding its reach
HTC has been around building devices since 2001 and so it would be a pity to exclude them from any analysis of the effect of iPhone on the market or any discussion on the effect of smartphone disruption on feature phones.
The challenge with HTC was that historically their branded devices and white label devices were not reported by the company separately. This matters because white label devices are valued differently. Typically these devices are not marketed by the original manufacturer so SG&A is not applied to their cost base. Operating margins, ASPs and hence profitability is not directly comparable with other OEMs.
But HTC has recently changed its reporting. Thanks to a reader I discovered that, since 2008, HTC has been listing its ASP and Operating Margin making direct comparisons possible. I still don't have all the data, but enough to add HTC to the analysis.
So, here are the 5 industry performance criteria, now with eight vendors listed.
Volumes
Note that HTC volumes start in 2008.
The volume of units HTC sold has been increasing at about the rate of market growth.
As a result, HTC's share has not increased as dramatically as those of the other smartphone entrants.
Sales
A similar story in the sales picture. Although a consistent performer, the growth has not matched that of RIM and Apple.
ASP
The pricing story is also a mixed one. Although HTC lies between RIM and Apple in price, the erosion is more consistent with RIM and the rest of the industry.
Margin
The margin story is also not as positive as one might expect. The margins for HTC started out above Apple and RIM but have dropped to closer to industry average. This is not what one might expect from an exclusive smartphone vendor.
Earnings
The share of earnings has remained unchanged at 5% over the period of iPhone presence. It's perhaps a credit to HTC that they did maintain their position in the market with the massive change that has come to pass.
However, here we also have to ask if HTC is riding a disruptive wave.
When I wrote the last series, my definition of “loser” was a company that had faced a long series of operating losses and has no viable software assets of its own, making it vulnerable to Android (and Windows Mobile). Motorola first, Sony Ericsson second and LG now coming into the picture. Nokia is not a loser in this sense since it has remained profitable and does maintain an investment in software. Same with RIM and Samsung (now with Bada). When/if they do have the near death experience, they might opt for the Android lifeline (flimsy as it is).
However HTC does not fit the mold of either "winner" or "loser". It's the Goldilocks company, not too hot, not too cold.
But I would add that HTC is not an example of a winner because of its adoption of Android. HTC’s dependence on Windows Mobile made their move to Android the most desperate of all. Unlike the larger OEMs, who had their low end devices to fall back on, they are completely dependent on a smartphone OS vendor. When WinMo was showing the first signs of crisis in 2007, they were the first to flee to Android (think of why they would risk the wrath of Microsoft for something so fragile as Android in 07). They are also trying hard to escape the dependence by building up their own UI (SenseUI) and I would not be surprised if they move to their own OS in the future. Being associated with Android does not confirm them as "winners" but in fact, shows their vulnerability.
What does this all say about Android?
Again here my thesis is that Google chose to sustain the industry rather than try to upend it. I don't judge their motives, but the fact is that with Android, Google is not in a position to disrupt telecom. There were high hopes dashed with the Nexus One and hearts broken with net neutrality and now there are patent wars to be fought. Android, with its licensees, is still at the mercy of operators.
On the iPhone, the firm raised their production forecasts from 14 million units to 18+ million, aided by easing constraints of display panels. Checks show consistent shortage of iPhone 4 inventory at Apple stores and there continues to be a three-week shipping delay from Apple's online store, the firm notes. As a result the firm has increased confidence in its 4QFY10 iPhone unit estimate of 11.6 million, which is up 39% sequentially.
On the iPad, the firm's build forecasts were revised up from 6 million to 7 million, which compares to their iPad shipments estimate of 4.75 million. The firm believes [there] is upside to the Q4 estimates and CY10 estimates of 13.4 million units, given the strong demand and anticipated production ramp heading into the back-to school and holiday seasons, as well as the high level of interest from business customers as expressed by AT&T.
These sound reasonable and credible. Note that production forecasts don't translate into sales forecasts as there is inventory, and some of that inventory will be held by Apple and some by the manufacturer.
My Q4 estimate sits at 12.1 million iPhones and 4 million iPads.
But seriously, how long has it been? Five months with no iPads on hand? Now if only they had enough iPhone 4's.
Here is the situation in Korea:
SEOUL (AFP)--South Korea's KT Corp. (KT) said tens of thousands of people jammed its website Wednesday, as it began to take pre-orders for Apple Inc.'s (AAPL) iPhone 4.
KT Corp., the country's sole distributor for the gadget, said in just four hours more than 70,000 people put their names down for the popular smartphone after its online shop opened.
"Our online shop server was jammed instantly as too many clients placed orders simultaneously," KT spokesman Jin Byung-kwon said.
"So far, the number of orders for the iPhone 4 exceeds well beyond that of the iPhone 3GS," he said.
The mobile phone market is intertwined with the telecommunications industry which is vast and there are numerous competitors which are much more dynamic and better capitalized than the moribund PC or music player vendors. It’s also a regulated and fragmented global market with 1.2 billion units and 5 billion consumers—far greater than any of the markets Apple played in for its first 30 years.
Nevertheless, the iPhone has had a huge impact on the industry. To show just how much of an impact, I dove in and pulled over 500 data points on three years’ financial performance of seven competitors responsible for 80 percent of units being shipped today. The time frame covers the iPhone’s participation in the market so it allows for “before-and-after” comparisons.
Now I turn my attention to draw a bottom line from all the data above, namely the operating earnings (EBIT or Earnings before Interest and Taxation).
The first chart shows the EBIT from the top seven vendors of mobile phones since the quarter when the iPhone launched. I annotated Nokia and Apple's bars to give perspective.
The total available profits in the industry dipped to a bit under $4 billion at the trough of the recession, and have recovered to nearly $6 billion in the holiday quarter last year. However, not all vendors are profitable. As you might expect from looking at the operating margins, Motorola and Sony Ericsson have been generating losses for most of this time period. They have both reached profitability in the last quarter, though at very low levels and after having lost a large part of their sales. LG has turned negative this past quarter after being a modest earner for some time. Samsung has maintained a fairly even consistency in its profit capture, though with its expanding market share, it seems to have come at the cost of pricing.
Finally, looking at the pure smartphone vendors RIM and Apple, the picture is nothing short of astonishing. This before-and-after share-of-available-profit chart shows that the two entrants went from about 7% profit share to 65% in three years.
Apple in particular is capturing about half of the available profits with three percent of the units. It dwarfs all the other vendors, more than double the nearest (Nokia). All that in three years and with the added burdens of only three models, a recession and limited distribution.
What does it all mean?
Here are my conclusions, enumerated:
The lack of a real response. The recurring theme in this series of articles has been that giant multinational incumbents in a vast and rapidly growing industry, enjoying all the advantages that size and incumbency, have had their profits taken from them. And they don't seem to have put up much of a fight.
It's all wealth transfer. Note the total amount of profit available has not increased markedly; this is not about incumbents growing the pie. Two thirds of what should have rightly been theirs moved from the incumbent shareholders to the entrant shareholders.
Speed. This shift of profit occurred over an unprecedentedly short period of time. Three years is no more than two product cycles in the industry and it's an order of magnitude faster than what happened historically to other industries.
Disruption is the diagnosis here. The incumbents were caught in the headlights. Disruptive innovation leads to asymmetric competition and this is what we just witnessed. History has shown that the shift of profits is usually the last stage of disruption and is usually irreversible because the change in business models cannot happen at the rate of change of profit transfer.
Which leads me to one final point.
When analyzing the potential for challengers to the new winners, the most cited is Android. Can Android affect this redistribution of profit once again? And to whom?
If Android is to become the dominant platform, does it depend on the success of its licensees? Who are these licensees and what are the chances that they will be able to align their businesses to what Android offers (a new revenue model based on services and advertising).
One problem I see is that Google is making a bet on those same vendors who are now squeezed in the middle of that last pie chart: Samsung, LG, Motorola and Sony Ericsson. Nokia, Apple and RIM will certainly not take the OS over what they already have as it dilutes their differentiation and margins. That means Android is aligned with the biggest losers in the industry.
So how likely are these disrupted ex-giants to recover and take Android forward? My bet: slim to none. Android does not offer more than a lifeline. It is not a foundation for long-term profitability as it presumes the profits accrue to the network and possibly to Google. Profit evaporation out of devices to Google may be a possibility at some time in the future, but only if the devices don't need too much attention to remain competitive. But because they're still not good enough (and they won't be for years to come), it's certain that attention to detail is what will be most important to stay abreast of Apple.[1]
So here we have the real challenge to Android: partnership with defeated incumbents whose ability to build profitable and differentiated products is hamstrung by the licensing model and whose incentives to move up the steep trajectory of necessary improvements are limited.
In other words, Android's licensees won't have the profits or the motivation to spend on R&D so as to make exceptionally competitive products at a time when being competitive is what matters most.
[1]: I would argue the same lack of symmetry with licensed software vendor Microsoft is what led the the failure of the same incumbents to make a dent in the industry with Windows Mobile [2003 to 2010].
Risku believes in the Stupid Manager Theory of business failure. It's still the overall most popular theory describing why large companies fail. It's so attractive because it's so simple.
However, I have several counters/questions to this theory:
When did management become stupid, exactly? The same group was in charge when the company was successful and the corollary to the Stupid Manager Theory is the Smart Manager Theory for describing company success. So how and when did they become stupid.
The conspiracy of simultaneous stupidity. How did *all* managers in a given company become stupid all at once? Did they conspire to lose competence together? Was there something in the water? Didn't anybody escape the stupidity pathogen? A further observation to be made is that when one company in an industry fails, it's usually not alone. Motorola, Sony Ericsson and now LG are in dire straits. Is the stupidity contagious across companies? Should we quarantine managers at firms like Samsung that have not yet been impacted? If the stupidity comes from reading market news, should we just keep them ignorant?
If the managers were always stupid then how did HR get so good at singling out the stupid (or those susceptible to stupidity after periods of intelligence). Isn't the remedy to simply act in perfect contradiction to their choices and hire only the people that HR rejects. After all, being perfectly wrong is a precious gift.
As of the end of the second quarter, Samsung’s global smartphone share was 4.8 percent, according to IDC. But LG’s presence was negligible.
[Update] From early 2009,
LG, the third-biggest phone maker, will produce about 50 models that run Windows over the next five years, said Scott Rockfeld, a director in Microsoft’s mobile business. Seoul-based LG will use the software as its primary program for smart phones, devices that can send e-mail and browse the Web.
So Oracle, who now owns Sun, who open-sourced Java(1), is suing Google over the way open Android is mis-using open Java.
Sounds like an open and shut case. I, for one, am looking forward to the opening statement.
(1) On November 13, 2006, Sun released much of Java as open source software under the terms of the GNU General Public License (GPL). On May 8, 2007, Sun finished the process, making all of Java's core code available under free software/open-source distribution terms, aside from a small portion of code to which Sun did not hold the copyright.
The research and development budget used to be 9 percent of revenue, Mr. House told me; now it was closer to 2 percent. “In the personal computer group, it is seven-tenths of 1 percent,” he added. “That’s why H.P. had no response to the iPad.”
HP, by sales, the largest technology company in the world, can't be bothered to spend money on R&D for its PC division. This is a surprise? Since when does any PC company spend any money on R&D? Put another way, even if they did spend the money, what would they be researching and developing? PCs are commodity products where any improvements would neither be valued nor used. On the measures of performance that everyone has for the PC, the product has been more than good enough for a decade.
They did not have a response to the iPad because they did not think anybody needed an iPad. And that is mostly because Microsoft did not think anybody needed an iPad.
None of this has anything to do with Mr. Hurd. His peer group all agree on these fundamentals.
After ASP, Sales, and Unit Volumes we look at the three year history of operating margins for the seven most significant mobile phone vendors (Nokia, Samsung, LG, Motorola, Sony Ericsson, RIM and Apple).
The following chart shows the OM from mobile phone sales. These figures are as reported by the companies with the exception of Samsung and Apple. Samsung reports OM for its telecommunications unit as a whole and we have to assume that it's largely accurate for mobile phones. Apple does not report margins for its iPhone but it's possible to estimate gross margin percent for the iPhone and then subtract its overall OPEX as percent of sales. This assumes that OPEX is allocated to the iPhone in proportion to sales, which is the best assumption we can make at this time.
The data shows that the iPhone has been considerably more profitable, due mostly to a high ASP, than other vendors. Motorola and Sony Ericsson have been "underwater" with respect to margin for much of the time period, with LG recently dipping into the red.
Nokia's margin erosion is a source of significant angst but note that it has just reached Samsung's historic level (around 10%). LG, long seen as an up-and-coming vendor who took over the number three spot from Motorola is shown to have done so with moderate-to-low profit margins.
Overall, the phone incumbents have an unweighted average operating margin of 4.5%, down from 8.6% three years ago. In contrast, RIM and Apple have an average OM of 34%, up from 24%. In other words, profitability has halved for the volume leaders while it has increased nearly by half for the entrants.
This goes a long way toward explaining the "smartphone gap" which is being filled by Android. As vendors see their unit growth, ASP and operating margins under pressure from low end disruptors, there is a tendency to flee to the high end that smartphones represent. Android offers an irresistible siren's song.
