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The post-Motorola dilemma: Same old-Google or the new Apple?

[Google's pending acquisition of Motorola creates a dilemma: Google must choose between staying true to its core business or reshaping into the new vertical giant that will challenge Apple at its own game. Research Director Andreas Constantinou discusses Google's dilemma and why both outcomes stand to radically change the rules of the Android Empire]

The post-Motorola dilemma: Same old-Google or the new Apple?

Google’s forthcoming acquisition of Motorola for $12.5B has been largely dubbed a patent deal. And it is. But beyond the patents, Google faces a fundamental dilemma for its core business, and one that will determine the future of the Android Empire.

In mid-August Google announced it intends to buy Motorola Mobility Holdings (MMI), which includes the mobile phone, set top box and DVR businesses, for $12.5B. The true cost to Google is much less though, given that MMI has cash and accrued tax benefits. The move has seen an unprecedented amount of analysis in the blogosphere, with a fair amount of guesswork as to what Google’s motivations were in buying a hardware company.

We believe that Motorola’s acquisition is not just about patents. The move marks a major turning point in how Google runs the Android Empire. Let’s see why.

 

The post-Motorola dilemma

We believe that the Motorola acquisition was sold to the Google board as a patent deal, with the hardware business being an unwanted but inseparable part of the package.

Now Google faces a fundamental dilemma. The combination of Google and Motorola is like building a skyscraper in the middle of the ocean; the two companies are built on very different business models.

Google is a profitable, 28,000-strong direct marketing company. Google uses Android as a platform with which to commoditise mobile handsets, flatten network access and reach billions more consumer eyeballs.

Motorola, on the other hand, is an unprofitable, 19,000-strong hardware company, one that uses Android as a ticket to sell more hardware to more consumers and more carriers in the form of smartphones.

We have no doubt that Google will divest a large part of the Motorola business. A hardware business would not help Google sell more ads, i.e. drive its core business.

Motorola accounts for less than 10% of Android devices sold in Q2 2011 – third after Samsung and HTC who shipped 18 million and 11 million Android devices, respectively, according to data from Gartner and Arete. By fully incorporating Motorola, Google would be just nudging forward Android device sales, while at the same time upsetting all of its major OEM partners. In other words, incorporating Motorola would have the same market impact as buying a local network carrier.

The question then is which parts of Motorola Google plans to keep, besides the patents. This presents a major strategy dilemma for Google – and one whose outcome will have fundamental impact on how Google runs the Android Empire.

 

Android as a software autocracy

Motorola’s IPR portfolio is substantial: 15,000 wireless patents, another 6,200 pending, and 3,000 granted or pending patents in the Home division, according to Arete research. More importantly, Motorola has a host of essential (blocking) patents around GSM.

These patents buy an Android Insurance Policy that Google can issue to “compliant” OEMs that are intended to protect these OEMs from “patent taxes” levied by Microsoft, Nokia and others. This Insurance Policy is essential to protect the vast Android handset population from stalling its so-far phenomenal growth. At the same time, this insurance policy is not sufficient if Apple does attack the mid-priced smartphone segment, as it is rumoured to do.

Android has been built on very shaky legal grounds, heavily “borrowing” from the Java language, the Java SE APIs and integrating with copious amounts of GPL-licensed code. Contrast that with how iOS, Symbian and Windows Phone platforms were built from scratch with very little inbound software licensing above the kernel. In other words, Google is buying Motorola to remedy the lack of IP strategy that threatens to undo 5 years of software craftsmanship. Google is paying for its past sins.

Moreover, the Motorola patent portfolio is comparable to Nokia’s, which not only buys Google insurance but puts Apple and Microsoft on the defensive – see the outcome of the Apple-Nokia patent dispute in which Apple has to pay Nokia 8 EUR per iPhone sold in the future, in addition to a substantial one-off payment.

But beyond the Android Insurance Policy, Google is getting something much more important: it strengthens the Android software dictatorship.

As we discussed here and here Google licenses the Android platform under an open source license but uses several control points to incentivise OEMs to stick to a tight software implementation (and one that goes way beyond APIs). Google’s Schmidt explains eloquently how “OEMs feel like they have a choice” with how they implement Android  [see video segment starting at 28m 50s] but in fact, they have to comply with Google’s requirements as they need G’s permission to add Android market and use the relevant trademarks on their handsets.

What patents buy by extension is practically a software autocracy; Google is now going to extend its Android Insurance Policy only to compliant OEMs. This means that if an OEM doesn’t follow Google’s precise software requirements, they will be prey to patent taxes by Google competitors. This now makes it untenable for an OEM to not pass Google’s Android certification.

 

Android as an Experience Licensing business

Besides software, there is a great deal of value that Google can leverage from Motorola. But that means a substantial change to Google’s business model.

Google’s business strategy is based on the economics of complements – that is, if you want to sell more cars, you need to lower the price of gas.

In Google’s case, if you want to sell more ads, you need to lower the prices of smartphones (Android), commoditise the networks (GTalk, Google Voice) and advance the state of web browsers (Chrome). Notice how everything complementary to Google’s business is “open”, while everything core to Google’s business is closed (Adwords, Android Market, Google Maps)

The Google strategy is to make Android smartphones as ubiquitous and as cheap as possible, with the lowest possible barriers to entry for OEMs and ODMs, so that the last citizen on Earth can be exposed to Google inventory.

However, the trouble with Android is that it has turned into a price-driven battlefield. The vast majority of devices compromise on the industry design and experience with cheap me-too plastics and poorly tested OEM apps and UI overlay. So far Android has managed to grow impressively fast as most devices are well below the iPhone and iPad price points. But with Apple rumoured to be releasing a lower-priced phone design, we expect Google’s empire of Android me-too clones to be challenged by the integrated, consistent and entwined experience that Apple offers.

This is where Motorola comes in. To counter Apple mid-priced phones, Google needs to tightly define and control the experience delivered on OEM licensee phones.

In this scenario, Google would use Motorola’s design teams to develop a complete “reference experience” that encompasses industrial design, hardware specs, complete software specs, marketing specs, pricing norms and of course the Google app suite. The Android open source “take it and fork it” mantra becomes much closer to a contractually enforced “experience licensing” business, in which OEMs that choose Android can compete with Apple on the same level, and get guaranteed margins through Google’s contractually-specified boundaries for Android handsets. How are OEMs going to differentiate you ask? Through regional marketing deals, retailer agreements and pre-loads with local service providers that deliver an additional rev share.

We envisage Android’s Experience Licensing scenario as borrowing heavily from the franchise business model widely practiced in the retail industry.  In franchise stores, the experience is as tightly controlled as the products, the marketing strategy and the pricing policy.

In other words, Experience Licensing is about running the Android Empire with Apple’s grip.

To accomplish this strategy, Google needs to seed the market with “Hero” devices that epitomize the Android experience. Here is where Google can leverage on Motorola’s device production assets.

A quick backgrounder: so far, Google has designed Android to offer three types of handset projects: Experience handsets (based on Google specs and branding), Partner handsets (compliant with Google’s Android specs, but with no Google involvement or branding) and DIY handsets (take the source code and fork it, but you ‘re on your own, e.g. China Mobile’s oPhone). The purpose of Experience handsets is to advance the state of the platform, by working closely with 2 pre-selected OEMs 6-9 months prior to the public release of the codebase under an open source license. Experience handsets (see full list here) are run under tight Google control and co-marketed by both Google and the OEM.

Google would be adding “Hero” handsets to the existing three tiers, which delivers two benefits.

Firstly, it allows Google to divide and conquer among OEMs without giving anyone “special privileges” or know how – it is rumoured for example that Google has been unhappy with the know-how HTC developed as a result of their long-standing relationship in the early Android days which has given HTC the fastest time-to-market for handsets based on the public codebase (note how HTC is no longer involved in Experience handsets for some time).

Secondly, it allows Google to better compete for carrier deals with Apple, by offering carriers exclusive access to the latest and best Android features on Motorola hardware. As we know, carriers die for exclusives, so rather than run Motorola device business at cost, Google can just keep the crown jewel features for carrier-exclusives from Motorola.

 

Redefining how Google runs the Android Empire

The purchase of Motorola makes Google the emperor of the Android Empire. Whichever parts of Motorola Google decides to keep, the laws of the Empire would be irreversibly changed. The how depends on which scenario Google opts for.

1. In the software dictatorship scenario (which we take as the default option), Google would make it untenable for OEMs not to follow its software specifications to the letter or to fork Android. Google stays true to its core ad business and divests everything apart from patents to a Taiwanese OEM wanting to break into the North America market.

2. In the Experience Licensing scenario, Google keeps the hardware design and device production capabilities to allow Android to compete head-to-head on every Apple price points, both the current high-end iPhone/iPad pricing and the rumoured mid-tier pricing. Here Google would have to take a hit on its cash flows and profitability by putting its hand deep in its pocket (both in terms of CAPEX and OPEX) to more favourably compete with Apple.

Irrespective of Google’s mobile plans, the Motorola acquisition offers the search giant a means to control the hardware and software make up of set-top boxes and offer a similar licensing program to Android TV licensees. We know that the first attempt at Android TV failed because there was very little premium content as content producers were concerned with DRM and content security. By controlling the hardware and software specs for Android TV, Google could bring the content producers back on board.

Historically, Apple has been fundamental to the success of Android. As it turns out, it is going to fundamentally challenge the Android business.

Stephen Elop noted in June 2011 that “Apple created the conditions necessary for Android”, by incentivizing carriers and OEMs to offer iPhone-killers at less than profit-killing prices.

Now Apple is creating the conditions necessary to challenge Android’s growth, by milking Android OEMs for patent taxes and challenging the Android clone empire with unique product experiences at more price points.

Whatever route Google chooses to take, it will fundamentally change the rules of the Android Empire.

- Andreas
you should follow me on Twitter: @andreascon

[Mystified by the intricacies of Google's  Android strategy? Check out our Android Game Plan workshop!]

  • Yuri

    Great analysis! I think that Google will do both of those things, but I don't see either of them as negative. First Google is protecting its investment, which is only to be expected, and second by staying competitive with Apple, they will continue to enable OEMs to profit handsomely too.

  • http://twitter.com/mjs1 @mjs1

    So much for the OHA.
    Based on this analysis it seems Google has declared itself Emperor (post Motorola) and the old oligarchy is suddenly threatened.
    How do you see the DIY'ers (oPhone, Baidu, Amazon?) reacting and will Samsung/HTC/SE/Huawei/ZTE flee the Android empire, begrudgingly stay as continued Partners/Experience players or hedge by travelling to other Empires (OS's)?

    • http://www.visionmobile.com/blog/ VisionMobile

      Hi @mjs1,

      Samsung/HTC/SE/Huawei/ZTE have based their smartphone strategy on Android – and some are hedging their bets on WP7. But there is really no alternative platform for them at this stage that a) has carrier drive and b) comes with a competitive apps ecosystem.

      Andreas

  • http://www.mobileforesight.com/ Jonas Lind

    This is an incredibly interesting blog post. I just have a few comments

    Perhaps the geniuses at Google don’t have a brilliant master plan and strategy. According to rumors (via asymco), Google started working on the acquisition the day after they lost the Nortel deal (5 weeks before it closed). The huge breakup penalty (2.5 BUSD) is an indication that they didn’t have the time for a proper DD and most certainly not for evaluating the value of the patent portfolio. According to FOSSpatents, the patent portfolio is not that strong if the purpose is to defend Android. My guess is that their legal counsel told them that Android was a house of cards and all their legal mistakes and cutting corners with Android over five years would soon explode in their face. They got panicked and saw the Motorola deal as the best way out.

    The smartphone market clearly shows that an integrated “vertical” product strategy (Apple, RIM) can deliver superior products with high profit margins. The horizontal PC-style Dell business model from the 1990s just doesn’t work if the purpose is to be a market leader. This is an argument against a horizontal player as Android. Even if Google manages to deliver a “reference design” to OEMs, I think that OEMs will be wary of this offer. If Google keeps all their know-how and just delivers templates, the speed of innovation will be slowed down at the OEMs as they lose the ability to integrate and innovate themselves. If Google has a two tier system with preferred partners and also-rans, the second tier players will most likely look for other platforms as they are officially discriminated. The first tier players will worry that even though they can deliver an iPhone-level product; they are not alone and have to face several other competitors with a similar offer.

    Google might also be tempted by the ultra-mega-high profit margins on the iPhone and iPad. Even if Android got a 70% market share, the value of the silly display ads are dwarfed by the profits from Apple’s hardware with a 20-30% market share. Exclusive Motorola phones powered by Android with the same profit margins as Apple and a 25% market share would most likely boost Google’s profits even more than Android.

    • http://www.visionmobile.com/blog/ VisionMobile

      Hi Jonas,

      Re: making a profit from Motorola phones: I don't think there will be much of a margin that would warrant Google's attention. Even at $50 per handset and 10M Apple-style handsets per year (extremely ambitious) that's 100M for Google which is 5% of Google's annual profits. However, the future is always hard to predict, so you never know if Motorola would manage to reclaim its old glory and increase volumes. My guess is it won't.

      Andreas

  • meedabyte

    Wow, I spent the last 20 minutes commenting but apparently my comment went lost :|
    Anyway, I'm not much into this dictatorship thing.

    Remember long tails and emerging markets: you cannot go for all with flagships (that, in fact, are not the best android performer on the market so far – Nexus, Nexus S, Xoom, etc…). Motorola is goint to offer much more a Google Experience but Android will still offer OEM freedom if Google doesn't want to kill an ecosystem that is finally on the rise.

    I expect Big G to invest more on domotics (thanks also to Android @ Home project) with the Motorola brand.

    Also, will be interesting to see what is going to do Samsung: is clear that HW is commoditizing lightining fast and that SW platforms make revenues while terrificly hard to build. Maybe a bet on Meego? Let's see. It will probably concentrate on HW at the end.

    Thanks for posting!

  • Tim Meyer

    "This now makes it untenable for an OEM to not pass Google’s Android certification."

    The only people who will have a viable long term model will be content owners like B&N and Amazon. Both are forking from Android, and I doubt anyone who buys those tablets/readers/viewers cares. They have a realistic chance of creating a price/value proposition that stands up to Apple and still make money.

    • http://www.visionmobile.com/blog/ VisionMobile

      Tim,

      The challenge Android and B&N will be facing is keeping up with the upstream Android codebase which is evolving too fast. If they want their devices to sport the latest Android apps, they will need to play by Google's book. If however they position their tablets as an e-reader centric (not an app-centric) device then they don't need Google's help or autocracy.

      Andreas

  • Gabor Torok

    Andreas,

    Not sure if you like cross-links, but here's another blog post that sheds some further light on this deal: http://www.rethink-wireless.com/2011/09/15/patent…. It becomes clear from this article that Google's only plan was to buy the patent portfolio, but Motorola's negotiating power was stronger and they could ultimately achieve the whole company to be buyed out.

    Gabor

  • Mass

    Very good analysis. Still I am puzzled that in the light of all this, the DIY companies still make big bets on Android. Like Amazon that is apparently has big plans to drive cheap devices into the market to sell content. From your analysis, whichever way G's strategy tilts, DIY lose. Do you think a company like Amazon is making a huge mistake?

  • http://www.quytech.com Sid

    A lot of people are missing the potential of Android tablets and the effect on the computing markets in Asia. A lot of local manufacturers are bringing out Android tablets for specialised uses. And they really don't care about getting Android Market on those tablets. The DIY companies couldn't ask for anything more:-
    1) A decent and free OS with good pool of developers to make custom apps.
    2) Reasonably priced hardware to make their business viable.
    Android combined with chinese mass manufacturing is allowing such companies to innovate. And these companies are making money out of it.

    As for Apple, it will be unviable for them to run after the smaller DIY manufacturers. In fact Apple would be happy to see consumers getting hooked on to low priced tablets. For when the same consumers want to upgrade, they will look at iPad as an option. I think the same holds true for the handsets to a degree.

  • DesDizzy

    The actual licence payment reported in the Nokia accounts 2011 Q4, under "other" was not the €800M widely reported but closer to €450. A bit of a flea bite for Apple.

    "Our overall Devices & Services net sales in 2011 benefited from the recognition in Devices & Services Other of approximately EUR 450 million (approximately EUR 70 million in 2010) of non-recurring IPR royalty income, as well as strong growth in the underlying recurring IPR royalty income. We believe these developments underline Nokia’s industry leading patent portfolio. During the last two decades, we have invested more than EUR 45 billion in research and development and built one of the wireless industry's strongest and broadest IPR portfolios, with over 10 000 patent families. Nokia is a world leader in the development of handheld device and mobile communications technologies, which is also demonstrated by our strong patent position."

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