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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]
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 â€˜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.
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