Cheap and high-powered mobile bandwidth will kill many outdated tech business models
When I started to write about the mobile space on Credit Writedowns three years ago, it was clear to me that Apple’s strategy as a sole hardware manufacturer earning high margins and maintaining dominant market share was limited. The question at the time was how much money Apple could earn before that strategy became vulnerable. Since then, I have written a number of posts on mobile space strategy (I leave the valuation stuff mostly out). But I haven’t re-visited the real bigger macro view in quite a while. I want to do that with the weekly here.
It is ambitious of me to try to write a wide-ranging piece on such a fast-moving and complex ecosystem in a blog post format. But that’s what I am going to try to do. Hopefully, it will be helpful to you in thinking about how companies in this space will perform. I hope to keep this at the pure macro strategy level – and that means avoiding a lot of jargon, numbers and stock talk. I am writing this from the angle of someone who is at once a tech enthusiast and early adopter as well as a former technology executive who worked on strategy.
The move to mobile
Why is mobile so important in the tech space? I think a lot of it has to do with processor speed and bandwidth (I know, the jargon has already started).
Think of it this way, 17 years ago when I was forced to switch to the PC from a Mac I opted for a $3800 Dell laptop system that had a computing processor that ran at 75Mhz, meaning its internal clock cycled 75 million times per second. Fast, right? Well, consider this: today, having switched back to the Mac, I am writing this piece from a MacBook Pro that has a 2.5Ghz computer processor. That’s 2.5 billion cycles per second – or 33 times as fast as my computer back then. Back then, I had a phone dial-up Internet connection that allowed me to receive computer data from the Internet at a rate of 28,800 bits per second. Now, my fibre optic connection at home runs at 25 million bits per second – or almost 1000 times as fast.
So, the environment here now is night and day compared to what it was then. And those advances have made possible packing large processors into little mobile phones that connect to the Internet at blazing speeds. My mobile phone processes at a clock rate 13 times as fast as my old laptop did and the Internet connection is up to 4 or 5 million bits per second, hundreds of times faster. The bottom line here is that I can do almost anything on my mobile that I can do on a regular computer, the only limitation being the size of the device.
But, it’s that mobility factor that greatly changes things. In the old days, you could lug your 12-pound laptop to a new location and plug it in to the network there. But, eventually WiFi meant you didn’t even have to plug it in. When mobile phone operators started to get serious about mobile data at the end of the tech bubble though, that’s when things began to change. Suddenly, you could access your data, your colleagues’ data and other people’s data not just using existing “infrastructue-based connectivity” but anywhere your mobile phone operated – and that’s a lot more places. I remember working in London and flying to Germany with my Nokia handset, getting e-mail, following sports, texting and more using the rudimentary mobile networks of the late 1990s.
The reason Blackberry handset maker Research in Motion took off is because they understood that the “killer app” for the nascent mobile space was e-mail and that the people who most needed it, business professionals, had the coin to pay for universal mobile access. RIM configured their handsets to take advantage of that particular mobile world with Nokia upgrading its offering to remain dominant in the consumer space.
But the lesson here is clear: when processing speeds and Internet bandwidth increase, so to does people’s ability and desire to use computing devices any- and everywhere they can.
The advent of high speed mobile
Eventually, processor and mobile connection speed was so high that people found themselves able to do a lot of things on the go that they couldn’t do before. And that meant, the Blackberry and the Nokia mobile interfaces weren’t going to work.
Enter Apple. Apple had reinvented itself as a technology company instead of a computer company with the advent of iTunes and the iPod. This was significant in terms of Apple’s understanding of how the computer’s grip on computing was waning. By the middle of last decade, people wanted access to digital content in a variety of places on a variety of devices to do a variety of things. When Apple launched the iPod in 2001, mobile was not robust enough to make a difference. But what Apple understood then was that the decrease in the cost of computer storage space meant that mobile platforms were increasingly attractive. And they moved heavily into the space where mobility was most important: music.
Digital technology had already moved music from analogue tapes and records to CDs in the 1980s. But now, with the help of computer processing speeds, compact disc digital music files could be compressed by a factor of 10 without significant loss of sound quality. Sony, ever innovative, had already gone mobile with the MiniDisc player that replaced its Walkman. I switched to that platform in the late 1990s. But, right about that time, you saw a proliferation of flash storage based mp3 players that killed the Sony model. With hard disk storage costs cut in half every six months, mobile digital players with laptop-sized hard drives became attractive. And that’s when Apple struck with the iPod in 2001. The iPod was a huge success that further moved Apple away from “Apple Computer” to Apple, the technology company.
By the middle of the decade, the drop in storage costs was no longer driving mobile adoption and so music was not the only “killer app for mobile”. In fact, it was increasing mobile bandwidth speeds that offered an opportunity – one that Nokia and RIM should have seen. But Apple, with its foray into mobile via the iPod, hit upon this opportunity fortuitously and was able to extend its music player dominance into a broader market via the iPhone. The key here was that Apple upgraded its user interface to touchscreen technology and tied the iPhone into its existing iTunes-iPod platform. As with the Mac in the 1980s, the user interface, the design was the crucial missing piece. The result was a category killer.
Remember though that the iPod and the iPhone are really little computers with flash or hard-drive based storage, mini laptops if you will. I know because I have hacked them and run different operating systems on them to suit my own purposes. The point of course is that, at heart, the iPod and iPhone story is one of taking computing mobile to different form factors because of the need, desire, and ability of users to compute in more places as processing and internet speed increased.
Once we moved from a world of one or two form factors (desktop and laptop computers) connected to home networks (your data), corporate networks (your colleagues’ data) or the Internet (other people’s data) via wired or WiFi networks to a world of proliferating form factors connected to networks via mobile networks, the cloud became the dominant computing paradigm.
“The Cloud” is a buzzword a lot of non-techies don’t get and also hate. But it has meaning and it is significant. What the Cloud basically is is the interlocking networks of data – whether it be your data, your colleagues’ data or other people’s data – that you can access anywhere and anytime. The Cloud is the difference between being chained to a workstation with limited data access and being free to ‘compute’ anywhere and anytime. It’s a big, big deal. There’s a lot that goes into the Cloud that I can’t cover here but suffice it to say it represents a paradigm shift in the computing world.
First there was computing; people used workstations to access data from mainframe computers in centralised storage facilities. Then in the 1970s, there was personal computing; this was a ‘revolution of computing democracy’ that decentralised computing and allowed everyone to maintain data, balkanizing the world of computer data. In the 1980s and the 1990s, wired and wireless networking re-connected these data islands both in corporations and eventually at home.
The Internet of the 1990s brought people out of the personal and corporate sphere and into a world of data ubiquity. In my view, the importance of this in terms of retail price discovery, crowdsourcing data and opinion, and deepening and widening information channels cannot be underestimated. The Internet and technology in general are deflationary forces. Think of Amazon and how its low price strategy kills retail margins everywhere. Think of Wikipedia, the blogospehere, and ancestry sites that are validated only through their reach to and approval by large audiences. And think of British newspapers that have significantly eroded American newspapers’ mindshare in the US after their critical reporting during the Iraq war. All of this was made possible by the Internet and the increasingly universal connection to other people’s data.
With high speed mobile data and processing speed comes the Cloud. We are on the verge of another paradigm shift. And it’s unclear what this means to incumbent business models and what this means for how people use data. I’ll tell you what I have seen and foresee. But this is by no means textbook stuff. For me, the big shift here was the Internet, when people moved from consuming computing data in their existing pods at home and work to consuming data and interacting with strangers on a daily basis. We already know that this has meant big changes in terms of social psychology via chat rooms, comment threads, and Facebook. But my general sense is that it is a democratisation of information flow. It basically means that the high priests of information like Newspapers, investment bank analysts and the like have to compete like never before to maintain their hold as primary sources of information and analysis. The fact that you are reading these words tells you that. Of course, this has nothing to do with the Cloud.
What the Cloud represents goes more to how people consume their information, data, and social interaction and, therefore, from a business perspective it’s more about the plumbing behind the scenes than what you see in front of you. Facebook, eBay, Google, Amazon, Yahoo!: those are Internet Phase 1 stories. Phase 2 is about what makes those companies’ data available everywhere and on every type of device you can imagine. So, my general sense here is that Phase 1 is sexier and more interesting to the public and to amateur stockpickers than Phase 2 will be. That represents an opportunity to people who are willing to do the deep dive and research companies that are not in the spotlight the way Facebook, Zynga or Groupon are. My view is that infrastructure plays will be the ones to benefit most from Phase 2 despite the fact that all the Web 2.0 IPO companies we have seen are consumer companies with recognizable brand names. Eventually we will see companies like Dropbox, which specializes in digital storage, and Cloudflare, which specializes in network caching, start to make a splash, since digital storage and fast connectivity are the heart and soul of the Cloud.
What the cloud means to existing businesses
For existing businesses, the cloud represents a challenge. Despite the impression people have that Facebook is a new company and that web 2.0 is ‘new’, the reality is that Facebook represents Phase 1 and it is struggling to deal with cloud computing. It’s existing revenue model is heavily dependent on serving up ads to people using workstation-like computer form factors. And that’s not what the Cloud is all about. So Facebook faces challenges.
Here’s how I see the Cloud as I wrote it in 2010:
“Going forward people will want to access ‘their’ content anywhere and on any device on any platform and have it work without a huge amount of technical know how. This is the world we are moving to. And that means Microsoft has a one-time window to move from its prior platform dominance into content gatekeeping via a more ubiquitous operating system or role as content king.
“The controlling element in the short-term is bandwidth. Despite the advent of broadband, we still live in a bandwidth-constrained world, especially in North America where home broadband speeds lag behind developed European and Asian economies. That also gives the legacy telecom providers a limited window of opportunity to extract rents and expand in scope while they have their gatekeeper position.
“All of the technology companies know this – from the hardware manufacturers to the Internet Service Providers and telcos to the software companies and Internet companies. And they are all re-orienting strategy around this shift (Intel, for example, is moving into Smartphone chips).
Apple and Google Will Dominate
“I really don’t think the Telcos or Microsoft will be able to make the transition without forfeiting their existing monopoly positions. Moreover, the desire to forestall the movement away from their legacy control is huge and that will mean organizational inertia stops them from making the transition deftly. Instead Apple and Google will rise to prominence.
“Monetizing the future computing world is important because a lot of the kinds of things we used to do (looking for information, searching for jobs, playing games, reading books) are going online. There are four ways to profit from this.
- You can have the content. This is the game my prior employer Yahoo! fought against Microsoft and AOL by building quality content. App developers for Mobile phone platforms play in this sphere by creating applications to view content. The problem, of course, is that the Internet is an open ecosystem and its very difficult to build a lasting franchise around extracting rents from apps and content alone. You can’t maintain a paid walled garden (Good luck New York Times and Rupert Murdoch) because people will get similar content for free elsewhere. Netflix can do it because there are few competitors. However, outside of a few examples (online commerce), advertising becomes a big factor. Gatekeeping becomes crucial then too.
- You can gatekeep by controlling network access. This is what telcos are trying to do, especially in squelching net neutrality. They want to turn themselves from dumb pipes into gatekeepers who can extract rents by controlling which applications and websites are preferred. Quite frankly, I see this behaviour anti-competitive. But, in due course, this kind of behaviour will invite competition and the telcos will find their monopoly rents diminishing.
- You can gatekeep by controlling the operating system. This is where Apple lives and breathes. Google plays this game via Android as well. For instance, I use Microsoft’s Bing as my search engine on the desktop but on my mobile I am forced to use Google because of the Android OS on my Nexus One. Apple can decide which applications to select for its devices and exclude any apps that reduce their ability to monetize their music and video content at iTunes.
- You can gatekeep the content. Google has come to prominence by using search as a content gatekeeper. Rather than building proprietary content, which is expensive, Google focused on search which is infinitely scalable. But since a large percentage of internet activity happens through search rather than people going directly to previously vetted content, that gives Google a gatekeeper role which they have monetized via advertising.
“I see a future computing world which is networked and platform independent. And that means gatekeepers of bandwidth and content will be the winners in that world. Over the short-term Microsoft and the telcos will play their part in protecting their legacy franchises in these arenas. But ultimately, people just want to get their content when- and where- ever they can. And that means the organizations which dominate the multi-device interfaces of the future will take on a leading role in technology, perhaps the leading role. Right now that looks to be a battle between Apple and Google because the mobile Internet is in an unprecedented early stage of growth. Mobile phones and mobile devices is where it is at. Research in Motion still has a chance to play a large role as does Palm given recent rumours about an HP hook-up. But Apple and Google will definitely be central in this game.”
The OS Wars
Two years later, it has turned out to be true that the mobile space really is all about Apple and Google as I said then. But to sum up this view with the advantage of hindsight I would say this: We are now increasingly in a world in which people can get access to any kind of data they want on any device from any location. And people actually want this freedom. To make money as a technology company in that world, you will need to control the data that people want in some meaningful way so that people are willing to pay you. You can take control at the data storage level, at the network level, at the device level, at the operating system level, or at the software level. But ultimately, you are going to need some measure of control that’s meaningful and in a way that other companies can’t replicate. If you don’t have that kind of control, you will need to acquire it or find yourself an also-ran in a competitive world who earns low or negative returns for investors.
Now, a company like Amazon or Dropbox or Box can get you by controlling data storage facilities. Telcos and network plays like AT&T or Cloudflare can get you too because they own the network traffic. The handset makers like Samsung are in a great position to make a lot of money too as are the telcos that sell their product because they can customise their devices to build brand and stickiness and lock us in. And App makers like Facebook or Google with Google Maps can make a bundle either through advertising, app sales or what have you by controlling the software that let’s us access their data and their networks. Twitter, for example, is trying to re-assert control over its software because it is realising now how important that control is. But I think it is at the operating system level where you are finding the most interesting battle.
Think about it: storage and networking are competitve markets, especially with so-called net neutrality ruling the roost. Verizon can’t price discriminate against bandwidth hogs like Netflix. So that leaves them as the provider of a dumb pipe with the lower margins this implies. And App makers generally haven’t found a way to control data the way Microsoft has done with computers and Microsoft Office. The fact is apps are less relevant gatekeepers in the Cloud unless you are running a social network since people have multiple other ways of accessing the same data.
So that leaves the area around handsets and operating systems as the arena to look at for now. And the huge profits at Samsung and Apple tell you that. The patent wars now ongoing are mostly an operating system war between Apple and Google. If you recall, I said the reason Apple was able to muscle its way into the music business and then into the phone business is because it is a design company that focuses on the user interface. Apple is about using positive user experiences to build brand, retain customers, and moving those customers to new platforms. So, for Apple, their competitve advantage is on the design side. That’s why we heard Steve Job’s epic 5-minute anti-Google rant in 2010 even before we heard about his wanting “thermonuclear war” to stop the Android menace. He knew from the start that Android was close enough to Apple’s operating system for the iPhone, iOS, that it could spell trouble. And so Apple has gone after Google via patent disputes with the manufacturers of phones that use the Android OS.
Here’s what I see happening. People want to get at stuff they use on computers anywhere. And that means using a lot of different devices. The key for the mass market is that those devices have to be easy to use, which also means the data has to be synced across the devices. Naturally, this creates platform stickiness which puts operating systems in the drivers seat in controlling user data. The question then is how to maximize platform stickiness and switching costs.
Apple and Google Strategies
Apple is trying to do maximize stickiness and switching costs by tying everything down, limiting choice as they have done in the past with the Mac and the iPod. So, for example, the iPhone only syncs music, contacts and calendars with iTunes, an Apple product. When Palm tried to break this tie, Aple upgraded iTunes, apparently with the sole intention of breaking the Palm sync. This tactic worked. iTunes is not available on other mobile platforms. Apple will not let telcos customise the iPhone and dilute Apple’s brands. Apple will not let Apps install on the iPhone except via Apple’s AppStore, where they control which Apps can be listed. Apple has a policy of not allowing Apps which replicate basic iPhone functionality from appearing in the Appstore and competing with Apple. The list of control mechanisms goes on and on. But the stratgey is to control the OS in order to sell as much hardware at as high a margin as possible. This is a ‘closed’ approach.
Google has decided to give its operating system away for free. And until recently it was not a handset maker. That means it inherently has less invested in closing the platform down because it can only win by increasing market share. Google allows customization. It releases its source code freely. It allows App sideloading and competing AppStores like Amazon’s. And it allows Apps in its store that fully replicate basic Android functionality. The premise here is that Google will make money from having a prominent or even predominant presence on its operating system. And so more Android handset sales means more money for Google.
The Apple strategy is robust as long as Apple can maintain margins and share, which they have for far longer than anyone thought possible. Google’s strategy was inherently flawed from the start because the company has ceded too much control of the platform to handset makers and telcos, fragmenting the platform in the process and giving Amazon an entry point as a competitor. If Google had to do it again, I am sure they would exert much more control over the platform by forcing device manufacturers to limit their customization and and by forcing them to also upgrade handset operating systems in a timely manner. Google has taken a two-pronged approach to backing into this control. First, it has purchased a handset maker, Motorola. That means that it can make as many handsets as it wishes that fit the “Google” way of doing things. But Motorola has still run into problems with telcos not wanting to go along and so this will remain a problem. Second and probably more successfully, Google has the Nexus program which gives handset manufacturers the opportunity to make phones and install things the Google way. The benefit here for the manufacturers is that Google will do a lot more legwork of maintaining upgrades and support and they will sell the phones directly to the public. This means lower costs, higher visibility and higher margins for the companies making Nexus products. To wit, the recently released Nexus 7 is the best-selling Android tablet of all time and more versions are to be released on October 29th, just in time for the holidays.
Apple’s problem is that it can’t possibly maintain share and margin when so many other manufacturers are on the Android platform. On some level, the Android platform’s openness is a double-edged sword because it has cost Google control but it has also fostered adoption. And now Android is pushing beyond Apple in share, causing Apple to go down market in both mobile phones and tablets. That is trouble for margins. Meanwhile, Apple is getting killed in the market share game even outside the slowing developed economies. Just today, Henry Blodget wrote of how Apple is miniscule in India while Samsung is king because of Apple’s poor distribution and high price point. And again, this goes to Apple’s strategic flaws; the bigger the market, the lower the price has to be and the more competition there will be. I have written a lot on this in the past so won’t re-hash any of it here. Suffice it to say that Apple has a choice between margin and share because it can’t maintain both. It may not be able to maintain either.
I am going to end it here. I haven’t talked about Amazon’s strategy or gone into greater detail on the patent wars. So there is a lot I have left out. And I will follow up with more on the shift away from computers and laptops and what that means for technology businesses like Intel, HP and Dell. But, I wanted to keep this at a high level. The overall message here is that we are now moving into Cloud Computing, which represents a paradigm shift. Incumbent technology companies with a strong presence on the existing PC platform need to make drastic changes to their business model to move to the cloud. Overall, the Cloud increases choice and so decreases the ability to gatekeep, thus eroding margins. Right now, the highest margins are found in the handset arena because that’s where gatekeeping is easiest to do. But there’s no guarantee this will continue to be the case. At a minimum, I expect Apple’s closed strategy to lose its appeal, with margin erosion being the indication that its model has suffered. However, I also believe that infrastructure plays are going to be a big factor in this next phase, putting venture capitalists and people with a venture capital mindset in the catbird seat in terms of making money.
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