RIM

Here are the highlights from RIM's latest quarter:

• 14.1 million BlackBerry smartphones shipped, 13 million sold through
• 150k PlayBook shipped with sell-through slightly higher. 800k PlayBooks shipped so far.
• BlackBerry subscriber base up to 75 million
• High growth cited for U.K., France, South Africa, Mexico and Argentina, Indonesia, Saudi Arabia and South Africa. RIM is the #1 smartphone vendor in the Latin America and Caribbean region. Sales outside the US, UK and Canada were 61% of revenues. US is now 20% of sales, UK 11%.
• Hardware growth outside the US was 56%
• There are 630 carriers
• 50k apps in App World with 5 million downloads per day
• Forecasting 11 to 12 million smartphones next quarter

Given the channel fill with a new product, the device business was marginal at best. The company obtained -1% growth y/y in units but 31% sequential growth from a transitional quarter. The average selling price (inclusive of service revenues) is $354 and about $280 excluding service revenues. I estimate that operating margins have dropped to about 11%. Not a good story, but one we have been warned to expect.

But a crucial new twist to the story is that RIM announced that they don't expect new BlackBerry 10 devices until late next year. That came as a surprise and the stock sold off significantly, valuing the company at well below book value.

Stepping back, the biggest surprise is that the company seems to have had no plan for sustaining itself.

Let me explain.

If you go back to 2005 or so the world of smartphones was a mix of modular OSs and integrated platforms, much as it is today.  Not unlike Android today, Windows Mobile was successful in licensing to dozens of vendors who in turn released hundreds of products. Symbian also was licensed but most volumes came from Nokia and they held the lion's share. Then there was the BlackBerry integrated solution which worked smoothly and had devoted fans who upgraded every chance they had and operators who were joyous at the new ARPU. There was also PalmOS as offered by PalmSource trying to be a "third horse" and unseat stodgy old Microsoft.

It was into that fray that both Apple and Google jumped. Google acquired Android in 2005 and Apple was busy polishing a version of OS X that would became iOS. In three and two years respectively these platforms would be in the market.

Regardless of the actions of rivals, all competitors must have faced the same questions in 2005: As technology was changing rapidly and as they all had access to component roadmaps, what is the best technology approach to this market? Should they embrace certain innovations to sustain their business trajectory? RIM had a tightly integrated software, hardware and service offering. What could make it better? Nokia was also basing its products on a more loosely integrated offering (nominally it was modular, but only just). It saw the writing on the wall and began developing a Linux variant (Maemo) as a potential candidate to replace Symbian. Microsoft was basing its solution of a modular approach. Windows CE was ok as a kernel but they had layers on top which were optimized around stylus-based user experiences (analogous to mouse actions). Could it take on a rich computing experience?

There were many experience candidates. Stylus, keypad, keyboard all had adherents. There was a lot of hesitation. After the iPhone launched with capacitive (finger) touch, resetting user expectations, it still took a year for many of the vendors to re-consider their technology plans. The weakest changed first.

Microsoft felt the pain quickest. They also had the least to lose since revenues from Windows Mobile were paltry. By 2008 internally they turned 90 degrees. They embarked on re-building their user experience and orphaning the Windows Mobile ecosystem and many of the vendor relationships they had built. Palm dropped PalmOS and built WebOS internally quite quickly. They licensed Windows Mobile as a stop-gap. Around the same time Nokia doubled down on Maemo and joined with Intel to form MeeGo. They did not orphan Symbian though and kept trying to adapt it to the new experiences and input methods.

But RIM did nothing. Almost nothing. They were the healthiest competitor. They felt no pain from iPhone's entry. The platform they had built was still growing and they were tweaking it constantly. There were always improvements to point to but fundamentally the code was limited. It was very difficult to adapt it to touch input and the first attempts at a touch UI were embarrassing. But there were no signs of a new platform that reflected the Unix-like competition.

As I pointed out in an earlier post, Unix-like operating systems were having their revenge. To a computer scientist the future of mobile computing would mirror that of personal computing in terms of architecture. The foundations of the early smartphones were built on constraints that were disappearing while being unable to accommodate new input methods. In other words, the early efforts were optimized around those constraints and sub-optimal for rich user experiences. They had to be. There were limited processors, memories and screens and battery life.

It turned out that all the early mobile operating systems were unsuitable for the advances in technology that came after 2007. Companies which were able to adapt or embrace Unix-like operating systems in a mobile context gained the ability to grow with the new input methods. The sooner they "pulled the trigger" on the shift, the better off they were. This is in fact what enabled entrants to gain footholds. Entrants entered with Unix-like OSs straight away while incumbents had to justify changing and the more successful they were the harder it was to justify changing.

RIM had trouble justifying this change. It waited until 2010 to finally acquire the QNX asset that would offer them a stronger software foundation.  It still had to adapt this acquisition and it looks like it won't be done until at least 2012, seven years after they should have started. And this should be seen as a sustaining technological change. A new OS is not a disruptive technology to what is already a mobile computer.

However, delays like these can be fatal. We see the impact on Microsoft who was earliest to push the reset button in 2008. It still took two years to rebuild Windows Mobile into Windows Phone and is now still struggling to regain lost share (less than 2% today). We see the impact on Nokia which was unable to affect a transition to MeeGo due to a litany of issues and had to throw in the towel on self-determination. We see the impact on Palm which lost its independence as WebOS was a bit too little too late.

These companies had the right technical strategies but suffered from execution and business architecture issues. RIM is years late in embracing what appears to be a sustaining improvement.

But whenever you see what appears to be a coordinated effort by companies to fail simultaneously you have to ask if the change they struggle with is really sustaining or disruptive. The pattern makes me suspicious that what RIM, Microsoft, Palm and Nokia faced was more than a failure to embrace a sustaining improvement. I suspect that the failure is evidence of tectonic shifting of business models.

Before diving into the answer to the question in the title, there is some new data to digest.

The latest from comScore shows consistency with the previous months of smartphone growth in the US.

• The growth rate was 607k/wk new-to-smartphone users. This is slightly down from 654k/wk for the previous month but up significantly from 450k/wk the year before.
• The penetration of smartphones reached 38.5% (non-smartphones are at 62%)
• The penetration should reach 50% before September 2012 with about 1.2% being converted every month.

The following chart shows the weekly add rate with a three-period moving average:

This chart is important in that it should first show signs of inflection in growth. That does not seem to be happening yet.

The installed base by platforms is shown below:

Android is estimated to have grown to 41.7 million users in the US, adding 2.5 million users in the last month. Android is adding half of Microsoft's entire US mobile base every month.

RIM BlackBerry lost one million users in October. RIM's slide has accelerated again with over 3.7 million leaving the platform in the last six month. With 15.5 million subscribers, RIM has fewer users in the US today than it did in late 2009.

iPhone gained 1.34 million. Installed share increased slightly to 28% from 27.4% the previous month. There are now over 25 million iPhone users (above age 13) in the US.

Windows Mobile/Phone had no perceptible change (-34k) indicating perhaps that the losses in Windows Mobile are being erased by gains in Windows Phone. Microsoft's platform stopped losing significant users six months ago. Whereas the bleeding has been stopped, overall number of users remains at a rather poor 5 million or 5.4% share.

"Other" which includes Symbian and WebOS lost another 184k users to reach only 2.7 million users.

There are still 144 million smartphone non-consumers.

Android and iPhone now make up nearly three quarters of all smartphone ownership in the US. That's a total of 67 million users. With no sign of slowing, the chances are that there are at least 100 million users still remaining to convert. Sounds like an attractive target. But that target is shrinking fast. The rates of adoption signal saturation of most likely buyers will happen toward the end of next year.

At least 25 million new Android users will be gained and at least 10 million new iPhone users will be created in the next 12 months. That's 35% of remaining non-consumption. Assuming some acceleration, it's not hard to see 50% being claimed by the two entrenched incumbents.

This leads to an interesting positioning question. Is Windows Phone destined to compete with consumption or non-consumption? If traction is not forthcoming in the next 12 months, that leaves a very difficult last 50 million available as non-consumers. They are more difficult as they will be late adopters and perhaps more price sensitive and less motivated by features.

Windows Phone still has quite a bit of opportunity outside the US, but in the US (and in Europe which is not much different) the competition will increasingly be with rival incumbencies not with non-consumption. As the custodians of the Windows franchise, Microsoft should be well aware of the inherent difficulties with competing with installed platforms.

There is finally enough information to try to give an estimate of the smartphone market as a subset of the overall phone market.

The chart to the left shows the overall picture.

To sum up: The smartphone market has now reached over 30% of shipments. Non-smart devices are at 69% of total. The individual phone platform shares are as follows:

1. Android (and Android-like): 17.6%
2. iOS (iPhone only) 4.4%
3. Nokia Symbian: 4.3%
4. BlackBerry: 2.76%
5. Bada: 1%
6. Windows Phone 0.5%

The past quarter was the first where there is evidence of significant non-seasonal decline in incumbent platforms. Both RIM and Symbian saw two sequential drops in volume. The iPhone had a seasonal (or, more accurately, transitional) decline. Windows Phone had a very modest increase in share from 1.3% to 1.7% share though this is well below a margin of error in the estimate.

Android (and Android-like) shipments ballooned to nearly 70 million but sell-through could be about 10 million less. Nearly one in five phones sold is now powered by an Android variant. A remarkable story since the share was zero less than three years ago

Of the vendors involved, here is the division of share:

Samsung achieved 26% share, nearly swapping share with Nokia over a single year. Nokia reached below 14% while Apple maintained above 14% but down from 19% the quarter prior. HTC overtook RIM with 11% vs. 9%. Sony Ericsson is around 6% and Motorola probably slipped below LG with 4% vs perhaps 5% respectively.

The absolute performance of shipments by vendor and platform follows:

      

  I maintained the historic distinction between integrated (green) and modular (brown) OS strategies to show how the value chain evolved. As Nokia swaps its share to a licensed Windows Phone the share held by integrated vendors is likely to shrink even further.

Does this mean it's the end of integration? Or even more importantly, as I have previously suggested the link, is this the end of innovation in the mobile phone market?

It would appear that with 30% smartphone share, the vast majority of phone vendors are ready to abandon any ambition to obtaining extraordinary profits from mobile devices.[1] Apart from Apple, there seems to be complete capitulation to being manipulated by platform orchestrators with unpredictable or opaque intentions.

The thesis of perpetual innovation rules this out. While new input methods offer a clue that visual interaction and the platforms that depend on it are not permanent, the fact remains that cloud computing and the coupling of additional intelligence that comes with it will enable new points of integration and the positioning of these points on new jobs to be done.

Stay tuned as we discuss the future of mobile computing. The best is yet to come.

Notes:

1. By extraordinary I mean margins above what a component assembler and distributor would be able to obtain--see the PC industry.

comScore published the latest data regarding US smartphone installed base. To summarize:

• Penetration reached 37.4%, an increase of 2.9 million or 1.24 points of percentage.
• Approximately 650k consumers switched from non-smart to smartphones every week during September
• Based on trailing average of six months' growth, 50% penetration will be reached by end of September 2012, though the trend is for accelerated adoption (see chart below).

Of the platforms available, Android reached 39 million users, RIM 16.5 million, Apple 24 million and Microsoft about 5 million. Smartphone non-consumers dropped to 147 million. Among platforms, here are the shares and total users:

In terms of user gain/loss here is the tally:

Android and iOS have continued to increase consumption fairly consistently while RIM has moderated user losses. Microsoft has also shown the fourth consecutive month of usage increase having increased users by 440k since May. The new Windows Phones seem to have at least stopped erosion of user base though that base is still nearly a third of RIM's.

Overall, smartphone non-consumption continues to be the largest competitor though one which is steadily losing.

Even though China may overtake it in the new few months, the US is the largest smartphone market and it's a good leading indicator of the way the industry in evolving. It's also being measured by multiple observers[1] and we thus have a better chance at understanding the rate at which change is happening.

---

Note:

1. Nielsen reports that 43% of the phones in use in the US now are smartphones in the US with Ages 25 to 34 having 62% penetration.

 

As shown in the yesterday's post, in the third quarter, overall mobile phone profitability declined. The eight vendors I use as a proxy showed a total net profit of $8.51 billion, down slightly from $8.57 billion and a drop of $9.01 billion in the first quarter.

Overall, the industry dropped by 1% sequentially but is still up 30% over last year and has a 20% compounded growth rate over a three year period.

• Nokia returned to profitability, though at $180 million it's only about 2% of the top eight.
• Motorola remained in the red with a small loss of $20 million, an improvement over the $90 million loss of the previous quarter. Motorola is being acquired by Google after an accumulated mobile operating loss of $4.69 billion since the beginning of 2007. It's unlikely we'll receive any updates on performance thereafter.
• Samsung had a great quarter with a sequential increase of 19% and year-on-year growth of 130%. The total profit amounted to 25% of the peer group.
• Sony Ericsson broke even with about $50 million in operating profit. Like Motorola its performance was barely break-even during the last four years and its also disappearing from our list of independent vendors as it becomes part of Sony.
• LG had its sixth consecutive quarterly loss and is now appealing to investors for more capital to continue operating as a smartphone vendor. Raising dilutive capital seems a radical approach and not one that inspires confidence.
• RIM had a sequential reduction in profit of 35% and y/y reduction of 30%. The company is exhibiting clear signs of decay and the stock market is valuing the company below book value.
• Apple profit dropped by 19% but grew 43% y/y during a transitional quarter. The growth remains 43% compounded over three years.
• HTC has a 1% sequential increase but a 78% y/y growth.

To illustrate the performance in terms of profit, pricing, volumes and margins, I developed the following chart. 

The solid areas representing profit are operating profit/phone in the vertical axis and volumes shipped in the horizontal. The blank areas above are the cost of goods sold per phone and the combined solid and blank represent the average revenue per phone.

Some of the areas are over-represented due to the lack of resolution available.

Using before-and-after pie charts for positive profits, we can see how the entrants (RIM, Apple and HTC) went from 6% of profits to over 73% four and a half years later.

I feel that this is somehow the end of an era. I've written before about the brutality of this market, listing 13 companies which were either merged or acquired or disappeared in the last decade. Now both Motorola and Sony Ericsson will soon be added to the list. On average, it's as if one phone vendor has disappeared every year for fifteen years.

And it's still not over. RIM is also becoming a going concern issue, and LG has a big question mark above it.

Of course, ZTE and Huawei and Lenovo are joining the list of competitors but I note that they are not focused on mobile phones. They are opportunistic phone vendors, depending on other businesses to compensate for the risks inherent in phone sales. It's interesting to note that neither Apple nor Samsung are pure phone plays.

In fact, of all the phone brands only RIM and HTC are exclusively phone-only companies. It may indicate something profound is happening. The notion that the development and marketing of phones as an activity independent of other business models may be coming to an end.

A few years ago, around the middle of the last decade, the mobile phone market was characterized by the rivalry between a few established vendors. These were Nokia, Samsung, LG, Motorola and Sony Ericsson. These incumbent companies had a broad portfolio of devices including smartphones and feature phones and basic phones. Many also sold networking equipment and were deeply engaged with their customers, network operators.

There was also a set of entrants who offered only smartphones.  They were quirky. HTC was a a prominent "ODM" or original design manufacturer who built phones for companies who added their brands and sold and supported the product. HTC made phones and PDAs for operator brands and for some large PC companies. It also began to sell phones under its own brand. RIM was also offering products that had evolved from pagers into email appliances with added voice capabilities. But RIM's products were not very good as phones. Voice was so poorly integrated that many people carried both a BlackBerry and a voice phone. Then there was Palm with something called a Treo which promised many things but did not quite deliver.

In 2007 something happened which changed the industry. It took a few years to even realize it was happening but by the time it was obvious, it had changed to such a degree that huge companies found themselves in financial distress. This chart illustrates the effect.

In a few short years the rivalry between incumbent handset makers has evolved into a rivalry between mobile platforms where the incumbents were caught in an increasingly unprofitable role of hardware integrators. Motorola is now being absorbed by a search company. Sony Ericsson is being absorbed into a consumer electronics company. Nokia is going through a potentially existential crisis and even abandoned its platform. Acquisition talk surrounds LG's phone efforts. Samsung is prosperous but sill at the mercy of its software suppliers. Even the entrants are starting to feel beleaguered. RIM, the oldest pure play smartphone company is trading below book value and has regressed in value to 2004 levels. Palm evaporated. A view into the changes is the rankings of the companies in terms of volumes, sales and profit as shown below.

How did large, powerful, smart companies let this happen?

It happened despite having a clear, front row view of the transition of the industry from mobile voice to mobile computing. The shift in the basis of competition from "connecting people" to "connecting people to data" ended up being a classic disruptive trap. Many will argue that it was the failing of individual managers. Perhaps, but how did they conspire to fail simultaneously?

When you see disruption happening, it's natural to seek out a cause, a pivotal magical "force" or event that enabled the weak to humble the strong--the proverbial sling that enabled David to defeat Goliath.

My hypothesis is that The Primary Cause for the shift of profits from Incumbents to Entrants has been the disruptive impact of a new input method. I illustrated this with the help of the January 2007 slide presented by Steve Jobs at the launch of iPhone.

Each new input method led to not just a disruption but new platforms and new business models. Each new "sling" victimized a set of historic companies. Mainframe and minicomputers, consumer electronics giants and now telecoms.

Just like David's sling, these technologies are not powerful in and of themselves, but rather, the way they are used makes them unpredictably sinister. The context of using capacitive touch on a handheld device rather than on a table-top makes it disruptive. Coupling it with high-speed mobile networks and powerful but efficient microprocessors made it into a force.

That is now ancient history. The consequences and repercussions are still being felt and weighed, but the smart money should be focusing on the next shift. From the time frame in the diagram above, it's clear that the cycle time between "Revolutionary User Interfaces" is shrinking. It's been five years since multi-touch. Is the next "RUI" already here? Is Siri the next RUI?

There are many things going for it:

1. It's not good enough
2. There are many smart people who are disappointed by it
3. Competitors are dismissive
4. It does not need a traditional, expensive smartphone to run but it uses a combination of local and cloud computing to solve the user's problem.
5. It is, in a word, asymmetric.

My disruptive hypothesis for Siri is that it shifts the competition from platforms positioned on a device to a "coupled" super-platform dependent on broadband and infrastructural computing.

Just after collecting enough data and observing patterns in it that give us clarity, It looks like things are about to change all over again.

 

Samsung no longer reports mobile phone shipments. The company's phone market performance reporting is limited to the following:

Shipment : High-20%↑YoY (low-20%↑QoQ)

ASP : Slight increase QoQ

As the company did not report volumes or ASP last quarter either, the QoQ (Quarter on Quarter) growth estimates are almost useless. The only fragment that might be useful is the "High-20% YoY" given that they did publish units for Q3 2010: 71.4 million. This leaves the question of what "High-20%" means. Here are some ranges and what the result would be:

• 92.1 million assuming 29% YoY growth
• 91.4 million assuming 28%
• 90.1 million assuming 27%

The "best guess" might be 91.4 million.

As the company also provides revenue for its mobile division (14.42 trillion Won) we can therefore estimate the average selling price: $142. Is this a slight increase? By a similar approach, last quarter's ASP was $139, and assuming exchange rates did not vary widely, this increase is small enough to be called "slight".

We also have a figure for the operating margin for the entire Telecom group (16.9%) which gives an operating profit of $2.2 billion.

The last piece of the puzzle is the number of smartphones Samsung shipped. Samsung said smartphones grew "more than 300%" year over year. That would imply 31.4 million. One estimate is from Strategy Analytics that suggests 27.8 but it's coupled to an overall volume estimate of 88 million (well below the 91.4 million estimated above). The Wall Street Journal published an estimate of 28 million.

I have no idea how to narrow down this estimate, but if we go with the one that claims the highest precision (27.8 million) we get an estimate of about 30.4% of Samsung's volumes being smartphones (what I call the "smartphone mix"). That is an interesting basis for comparing Samsung's smartphone business to other companies' smartphones. I prepared a graph showing how pricing is affected by the increasing mix of smartphones in vendor portfolios.

What the graph shows is the movement of prices as companies have increased their smartphone mix since Q1 2009. For example Sony Ericsson moved from 31% smartphones to 80% smartphones in about a year. Their ASP increased from $184 to $231. Some companies have not changed their mix. Apple, HTC and RIM have maintained 100% smartphones in their portfolios so their pricing has been consistently high ($650, $354 and $357 over last 12 months, respectively). Conversely, Nokia has struggled with its smartphone portfolio and as a result its pricing has remained stubbornly clustered below $100.

But the most interesting companies to watch are Samsung, Sony Ericsson and Motorola. You can see how their "vectors" or price migration point toward the sweet spot where HTC and RIM reside. Ideally, they would be very much better off with pricing in the $300 range.

Samsung is moving quite rapidly toward the sweet spot but the slope is not as steep as the others. That's may be because SE and Motorola have much smaller volumes but it's still an open question why, with an estimated 30% mix of smartphones, the pricing remains $60 lower than when Motorola was at the same mix or $40 lower than Se.

Some of the answer might be due to the number of "low end" smartphones (Bada?) that Samsung is selling or maybe their non-smartphone pricing is trending down a lot more rapidly.

Keep in mind that if we change the assumption of the number of smartphones to a lower number (i.e. below 27 million) then the trajectory of the Samsung line in the graph would increase and may match more closely the slope of the other two vendors.

I don't have any reason to believe that it's lower than 27 million but I don't have any reason to believe that it's above 27 million either. It's an estimate.

If we believe it then we have to say that with a near tripling of smartphone mix (from 11% to 30.4%), the company grew its overall units by 28% and its revenue by 39% and pricing by 17%. Profits also grew by 130%.

It would follow then that switching to a 100% smartphone mix would make a lot of sense.

The August comScore mobile survey (MobiLens) is out. It measures the penetration or consumption of various mobile products and services in the US over a three month period.

I track the change in this data over time. Here are some highlights:

In August about 520,000 users switched to using smartphones (from non-smart phones) as their primary phone. This is a bit down sequentially from July but about average for the period starting January 2010.

Penetration increased by about 1 % to 36%.

Extrapolating this growth implies 50% penetration by September 2012. However growth is accelerating slightly so that tipping point may come sooner. Separately, T-Mobile reported that 75% of its device sales during this year have been smartphones, so if this is indicative of overall US market, then by next year it may in fact be quite difficult to find any non-smart phones to buy.

Among the smartphones, the different OSs have the following installed bases:

The growth in both Android and iOS has been fairly constant for the last 18 months.

Microsoft seems to be stabilizing at around 6%

But RIM shows an alarming deterioration. The company has lost 4.3 million users in the last year and is now at about the same number of users it had in late 2009. This is in a market that has more than doubled.

With only about 16.5 million US users and an average loss of half a million users per month, unless something drastic happens, RIM could lose its entire US user base by the end of next year.

During the last month alone RIM lost 1.2 million users. Management insists that new devices will boost sales but here we're measuring the erosion in core users, not upgrades. It's much more likely that those 4.3 million who left BlackBerry went to other smartphones. To move from a BlackBerry to a feature phone seems very improbable to me.

That means that BlackBerry's pain is probably iPhone or Android's gain. This sort of switch is often painful and I can only imagine that it's done with some reluctance. All the more remarkable then that RIM could not offer incentives to stay. The BlackBerry brand is fading rapidly and brand value is very hard to re-build.

There's one more thing.

We can see platform rivalry in the installed base chart but the bigger battle is the competition with non-consumption. The following chart shows how overall platforms are faring as they carve up the feature phone market.

There are still 150 million Americans whose primary phone is not a smartphone. The conversion of those users is happening at a consistent pace but there are many years of growth remaining. I've often wondered if and when this pace would moderate. I suggested perhaps at 50% there would be an inflection point as the "easy money" would already have been made.

Much of that will depend on how the product (device + service) will be priced. It's hard to get data on overall pricing. We can get some subsidized phone prices (for example now ranging from $0 to $400 for iPhone and probably similar for Android). What we don't have is an average device+service price point for the industry. That's what I would like to keep an eye on.

In an Harvard Business Review post Rob Wheeler makes the case for the Kindle Fire as a disruptive innovation. I believe that it is but crucially I disagree that the Kindle Fire is a low end disruption.

My assessment of the Kindle Fire is based on the two attributes which Amazon highlights as the key selling points which offer a basis of differentiation and potential for asymmetric competition: a low price and a new browsing model. I believe that these two attributes result in two opportunities: one for low end disruption and another of new market disruption. I reject the first and tentatively support the second.[1]

The price

It's immediately obvious that the price point of the Kindle Fire is well below alternatives. That forms the basis of disruptive potential, but before we jump to analyzing the disruption hypothesis we should determine whether and to what extent Amazon profits from the device directly. Profitability gives us a clue to where Amazon will apply resources and thus establish its trajectory of improvement.

We know the margin on the Fire is low because we can calculate the bill of materials for 7" tablets. Gene Munster of Piper Jaffray estimates that Amazon "loses" $50 for each unit sold. We also know that the design Amazon used is essentially very similar to the RIM PlayBook and was sourced from the same ODM. RIM priced the product at $499 but has struggled to find buyers and is reluctantly dropping the price. We also can estimate that Apple with a product having more than twice the screen size is keeping modest (~30%) gross margins for at a price point approximately double that of the Fire. It does seem that Amazon does not have much or any margin to dip into.[2]

So the Fire can be classified as a low price product. Does that make it a low end disruption?

Disruption requires asymmetry but it also requires the ability to go up a trajectory of improvement along the basis of performance that a majority of users demand. The first condition is met, but what of the second? In a combined system where one asset is used to leverage another--the subsidized being sacrificed to benefit the profitable--success is conditional on one element being "good enough" while the other "needing improvement". Investment follows accordingly.

But investment decisions have consequences. The subsidized device is starved of investment while the profitable service is nurtured. We see evidence of short cuts in investment in the off-the-shelf nature of Kindle products: from a second-hand (unsanctioned) OS to a second-hand (ex-RIM) hardware. Meanwhile, Amazon spends heavily on capex for the infrastructure that delivers the profitable content.

If the hardware is indeed commoditized and cannot be usefully improved, then this model works. If, on the other hand, the hardware and systems software can benefit from dramatic improvements in technology then the model fails. The very asymmetry of a service vs. a product turns into the latter having all the advantages and the former failing to gain traction.

I'll give three examples of this how service model creates limitations which lead to a failure to disrupt a product model.

The Game Consoles

The first is the game console business. In consoles, the vendors maintain long hardware product life-cycles to recover their hardware investment and subsidy by maximizing the number of games attached to each console. If you plot product cycles you realize that the bigger the subsidy, the longer the hardware lifecycle. The result is a very wide turning circle which prevents innovation in new dimensions.

Consider that the Playstation or the Xbox could have been a low end computing disruption. The original Xbox was in fact a PC. It was supposed to bring PC dynamism to the console business and create a cottage industry of new developers building games on commoditized hardware. However by the second generation the Xbox was a locked down, custom architecture, pure gaming machine. Gone was Intel, gone was the PC architecture and gone was any dream of cheap development.

This is entirely due to the economics of subsidized hardware. It compelled Microsoft, the world's greatest software company, built on the open and cheap PC architecture to make closed, expensive hardware. Sony followed in kind as did Nintendo. Each generation of consoles was a sustaining improvement on gaming and had no ambition beyond gaming[3]. The subsidy and the dependence on an integrated content value network led to a distinct lack of disruption and an insular industry which continues to seek out increasingly immersive experiences for increasingly demanding customers while itself being disrupted by casual, mobile gaming.

The Set-top boxes

The second example is the TV set-top box business. There again, the vendors maintain long hardware cycles in order to recover subsides. There too, the main value driver is the content and its distribution which stipulates the architecture, and through subsidy, defines its evolution. This offers the vendor no motivation to improve the user experience[4], secondary uses or the absorption of new streams of content (like those the internet can offer.)

Again, the set-top box could have been a budding disruptive opportunity for Microsoft. They invested billions in the 1990s to acquire placement of software on set-top boxes in an attempt to penetrate the living room. And again Microsoft was not alone. Since then Tivo, Google and Apple and many others tried to attach cheap hardware to video streams. They all failed to get on a disruptive trajectory. And again, the blame can be placed on the stifling effect of subsidies and dependencies on services or content which dictate where the value and hence the investments should go.

The Blackberry

The third example is the RIM Blackberry. Although RIM made most of its money on hardware and was by no means subsidizing it, the differentiation of their product was undoubtedly its service value. Both as a corporate device with BES and as a consumer device with BBS, customers "hired" the product as a service. By being committed to this model RIM management became blind to the hardware and client OS software innovations coming down the pike.

Through their own admission, they could not accept a touch screen because it would make the messaging experience too slow and it is messaging that sells Blackberries. They could not accept apps (and hence platform orchestration) as a differentiation because their customers did not hire Blackberries for "lifestyle apps". Merely being differentiated as a service leads to blindness and enough hesitation that you run off the disruptive rails.

People ascribe myopia or incredible absence of mind to RIM's management but the opposite is true. They were deeply committed and observant of the things which made the Blackberry successful. It just happened to be something that stopped being relevant.

The iPhone

I'll add one more "bonus" example on this. The iPhone is also a subsidized product and it seems very successful. How come it won? The answer is in details. As I mentioned, the other products ended up in poor life cycles or incorrect motivations. The iPhone differs in that the lifecycle of the product is much shorter (2 years ownership with 1 year for product updates). The shorter lifecycle works for the iPhone because it has a very high service revenue base to dip into to offset the subsidy. Something none of the content models above could count on.

Consider that each game console subsidy needs to paid off by a handful of game titles whose royalties to the console maker are modest. Or that the TV box needs to ride on top a service that also has thin margins from a stable or slightly shrinking user base. In contrast, the iPhone enables vast new consumption worth thousands of dollars to the operator. This is the famous ARPU uplift that smart phones enable. Users are doubling their telecom spending when they move to smartphones.

The margins for Kindle content are thin. Very thin. Apple runs its content business at break even though it transacts billions of items per month. The amount of content that needs to pass through the Kindle ecosystem (with lower prices than Apple charges) will need to be astronomical to make it profitable on the shortened cycle time the iPhone enjoys. Thus the Kindle is likely to languish in a leisurely update cycle with users encouraged to hang on to their devices for years. This is the case at least with the original e-Ink Kindles. How eagerly awaited are new generations? How many users stampede to update the hardware or even upgrade the software? How many users have owned every version of the Kindle?

Service Scale

Finally one last point about services. As Amazon asserts, they see Kindle as a service, which, I concede, is asymmetric to a product business. The problem is that services don't scale as well as products. Consider that none of the content streams that Amazon will depend on are available outside the US. The Kindle has not been a strong seller internationally. This is because book rights are limited to national boundaries as are movie rights and song rights. Apple has only this week finally completed the rollout of iTunes music to all of Europe! A process that took almost a decade. And they are still unable to sell music in most of Asia and forget about movies or TV shows.[5]

The reality is that there are no global service brands. Not in telecommunications (operators are, at best, regional), not in Media (TV, radio, publishing are a local businesses), not in Banking (not even in commercial banking) and not in Retail (even Wal-Mart was humbled trying to export its disruption). The internet has not broken down any of these boundaries and even Amazon has modest reach outside the US for any of their franchises. Services are local but products can be global.[6]

To wrap up, this discussion on the asymmetry of device-based services to product models leads me to conclude that the Fire will not have the opportunity to disrupt the iPad or tablets in general. Amazon sees the hardware and software of a device as a commodity and the content and its distribution as valuable. This assumes that the device is "good enough" and will not require deep re-architecting or that new input methods can be easily absorbed. In short, they see the tablet as at the end of its evolutionary path. Apple sees the exact opposite. The iPad is 18 months old, and as they say in the ads, they see it as only the beginning.

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Notes:

1. Due to length of discussion, in this post I will make the case against the low end disruptive potential and use a second post to make the case for it being a new market disruption.
2. Presumably, Amazon will also distribute only through Amazon.com and thus not incur channel mark-ups. This means that comparisons with other tablets should be at a price nearer to 70% of retail.
3. Gaming networks and video streaming are extensions but neither leveraged open architectures.
4. See also discussion from June 2010 on the challenges to Apple TV that Steve Jobs enumerated.
5. Apps are another story. Because it controls the medium, Apple can and does sell apps in every country where the iPhone or iPad or iPod touch is available.
6. Note also that because of distribution through Amazon.com, the Kindle cannot reach as many buyers as a tablet selling through the tens of thousands of points of purchase that operators and retail shops offer.

 

RIM shipped 10.6 million Blackberries and 200,000 PlayBooks in the last quarter. Management noted that their sell-through was significantly higher for Blackberry (13.7 million) but seems to be very weak for PlayBook as the prior quarter saw 500k units shipped. Additional PlayBook units this quarter probably mostly went into new channels in Asia and there were no additional sales into North America or Europe.

The figures for units are very poor. How poor depends on the frame of reference. Consider the shipment chart below:

In terms of the competition, 10.6 million units is less than half what Apple or Samsung sold in its prior quarter. It's also less than what HTC sold. RIM's volume rank will likely go to fifth place as a smartphone vendor.

In terms of its performance relative to its own history, the Blackberry volume dropped by 11% year-on-year and 18% sequentially. This is the second quarter that shipments shrank.

In terms of market share, we'll have to wait for the competitor data over the next six weeks but the market has been growing at an average of 77% for four quarters so any continuation of this trend would imply RIM's share dropping to single digits.

Finally, the biggest shock has been the decline in profitability. It seems that operating margin dropped from 21% to 13%. The company did incur some one-time charges for recent layoffs, but even without that charge, the margins would be around 16%. This is most alarming. The reason for such drops is that as volumes decrease fixed costs don't decrease as rapidly or at all. The company still needs to keep sales, administration and engineering staff around and they become a larger part of the operating expenses (vs. the component costs which vary with volume of goods sold).

This effect is well understood by financial analysts and the stock price shows it with a huge drop.

But stepping back to look at the picture above, there is a clear turning point in the company. You can see the elbow in the curve for volumes whose effect is felt so deeply. What's curious is why the pivot occurred when it did. We can point the finger to competition as the cause. But why was there no effect in the company's fortunes when the competition actually emerged. It's been years since the iPhone and even Android entered the market. Yet we see an impact on Nokia and RIM individually at apparently arbitrary points of time.

This is the lament of the analyst: you can clearly and accurately state what will happen but when remains a mystery. It's the elasticity between obvious causes and their effects that makes this an inexact science or not a science at all. In retrospect, you can say that Nokia's pivot was triggered by its public execution of Symbian, but that assumes that it was preventable--which we know is not the case. But what caused RIM's change of growth, exactly? Why did it happen this past spring? Why didn't the company volumes begin to decline as iPhone and Android boomed in 2009 or 2010? For quite some time RIM seemed immune to competitive pressure. We all were made fools as we called its imminent demise. Then, as Steve Jobs would say, boom!

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Footnote:

Piecing together RIM's performance is becoming more difficult each quarter. The data being presented is increasingly obfuscated by irrelevant detail while major information is omitted. This last management presentation was full of holes, namely:

• We have no idea of device pricing. Valiant efforts have to be made to piece together that aspect of the business. Matt Richman does a good job but it still requires some guesswork regarding PlayBook pricing to back out Blackberry pricing.
• Management detailed where Blackberries were selling-out but only detailed sell-in for the PlayBook. Obvious spin.
• They are cherry picking the data they present and each quarter it's a different story making pattern recognition impossible.

This leads to an erosion of trust. Observers are faced with the problem of increasingly guessing what is happening each quarter. For instance, regarding pricing I prefer to include service revenues in the analysis of device sales because device+service is what is being bought by the user and vendors which can offer services as part of the device get a justifiably higher value for the product--value that I think needs to be considered as advantageous. Nokia and Apple also account for services (though not apps) as part of device sales and it makes it more convenient to compare these businesses.

Given RIM's smokescreen, this quarter I decided to stop trying to guess Blackberry pricing and used Operating Income/Units sold as the average selling price.

 

Yesterday comScore published survey results for EU5 (France, Germany, Italy, Spain, UK) on smartphone use and installed base. The headline is very similar to what would be written about the US: Android had phenomenal growth over the last twelve months. I also noted that the apparent growth of Google (16.2% share change) seemed to be matched by an apparent decline of Symbian (-16.1% share change.) However the reading of the data is not so simple.

In order to understand what has happened to usage, it's much more valuable to look at consumption and the actual number of users rather than change in share of a subset of the market. Consider the following charts:

The bar chart shows that three platforms gained users in the last year (ending July) and that there were negligible losses in users by others. Negligible except for non-smart phones. A remarkable 29 million users moved from non-smart phones to smartphones. Those switchers switched into Android (16 million), iPhones (6.3 million) and RIM (3.4 million). Symbian even gained about 330k users. Microsoft lost about 1 million but its platform has not been actively promoted in that time.

When seen as a pie chart, you can see how the usage shifted from non-smart to smart even more clearly. It does not appear that Android took share from Symbian at all. Android took share from non-smartphones. The table in the link from comScore leads one to conclude otherwise.

I took the same approach to look at the US data (also from comScore). It shows a similar pattern.

In the US, RIM was a net usage loser but its losses also paled to the losses of non-smart devices. In comparing with EU5 the pattern is very similar.

I then combined the EU5 and US data and provided a view into the combined markets (note scale change from previous two charts.)

This shows the change in platform phones more or less being from non-smart to Android and iPhones. The total population is 470 million people--not insignificant. The total number of non-smart devices abandoned is nearly 60 million in one year, which equals the total number of new smartphone users. That's 12% of most of the developed world switching in one year. If this keeps up, the "tipping point" when smartphones will outnumber non-smart phones in use in these large markets will be in another year.

In terms of sales rate, the tipping point has already happened. Sales of smartphones crossed over in the US and Europe several quarters ago (November 2010 in EU5) and the trend is accelerating. Furthermore, if patterns of mobile technology adoption repeat as they have for the last two decades, emerging markets will follow in two to three years.

This tipping point observation has been repeated on this site a number of times when reflecting on the data in the US. Now it's becoming clear that the same pattern has been underway in Europe as well.

The big picture from the survey data is just how vast the demand for smartphones is. Some platforms are benefiting more than others in terms of share of growth, but the biggest mobile loser is clearly the non-smart phone. Not only is it an unprofitable product for almost every vendor, it is also being increasingly shunned by buyers.

At the same time, at 450 million users we're still only looking at less than 10% of the market. As this pattern spreads globally the platform install bases will be measured in the billions of users.