Et tu, Google?
By: Kevin Romano & Ryan White
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
Rome was not built in a day, but over years of battle, conquest, and deal making. Its rise was led by Julius Caesar, a dictator whose newfound power grew so strong that it threatened to destabilize the Empire. He was assassinated by those closest to him in a pre-emptive attack. Today, Google faces this same dilemma: must Samsung, the modern day Caesar, be killed to save the Empire?
In 2007, Google founded the Open Handset Alliance (OHA), a group of 34 companies, including HTC, LG, Sony, Motorola, and Samsung, to “accelerate innovation in mobile and offer consumers a richer, less expensive, and better mobile experience.” At the heart of this consortium would be Android, a jointly-developed operating system (OS) that would be free to all members to use, customize, and contribute towards. The success and growth of Android has been staggering, yet the spoils of this growth have not been equally shared.
During the 2012 holiday shopping season, Samsung controlled an astounding 98.5% of operating profit among Android device manufacturers. Not only has awareness of its Galaxy brand eclipsed that of Android itself, but as hard as it is to believe, Samsung makes more profit from Android smartphones than Google does as a whole. Even HTC – Android’s second largest vendor and maker of the platform’s first handset – has seen operating margins tumble to 1% and its market share drop by 80% since 2011. To make matters worse, Samsung has recently begun removing any association to Android, choosing to brand its phones as “SAFE,” or Samsung for Enterprise. Many suspect the company will soon transition away from operating purely on the Android platform, as marketing Galaxy devices to enterprise consumers is difficult when the smartphone runs on an OS susceptible to hacking.
Gone are the days of Android versus iPhone. Today, it’s Samsung versus Apple. The Samsung brand has now surpassed the Android brand in consumer mindshare. While consumers used to buy Samsung devices because they were running the Android OS, they now purchase them for the Galaxy brand name.
The acquisition of Motorola is resulting in a loss from operations equal to 1/14 of Google’s total revenues.
Google’s mobile data collection pipeline has transitioned from being supplied by a wide range of OHA members to overdependence upon Apple and Samsung. At its core, Google is a data company; it gathers, analyzes, and monetizes data like no other firm, so this perilous source of mobile data is worrisome. Given 90% of the world’s data has been created in the past two years – largely due to the proliferation of smartphones – the loss of a stable data source would have serious repercussions for the search giant. Android remains Google’s mechanism to capitalize on data flow, but should Samsung flee the ecosystem, Google’s core business will be at risk.
A Man Amongst Giants?
Google’s mobile data flow is dependent on two channels: the use of the Android OS and its affiliated applications, and the use of Google as a default mobile search option. Apple and Samsung exert significant control over this information stream; combined, the two companies account for 69% of the smartphone market and 106% of industry profit (when taking into account losses incurred by other manufacturers). Should either of these companies shut out Google, its data pipeline would quickly dry up.
Apple
The feud between Apple and Google has been well documented. Google cannot afford to lose iPhone users, as they generate Google four times more revenue despite being three times fewer than all Android users combined. Google even pays Apple a yearly fee of $1B to remain the default search provider on iOS. However, Apple keeps inching further and further away. First, it attempted to switch from Google Maps to Apple Maps. Then, in 2012, there was the glaring omission of a preloaded YouTube app on iOS 6 devices. Most notably, Siri’s direct attack on Google’s search business. By accessing specific databases directly, Siri bypasses Google from the search market, thereby threatening Google’s main revenue source. As this relationship becomes even more strained, Google must think proactively about a world where accessing data through its largest customer, Apple, becomes increasingly unpredictable.
Samsung
At first glance, the Samsung relationship appears to be much stronger. Samsung uses Android across a suite of product lines, while its powerful market position drives Google’s data collection. Yet there are concerning signs about the future of the Google-Samsung relationship. Samsung has plans to use other OSs on its high-end smartphones including the Linux-based Tizen, an OS developed in part by Samsung. With a planned August release date, this non-Android Samsung phone has just been released to app developers and is expected to compete in the same high-end space as the Galaxy and iPhone lines.
Google search interest over time in the US – Samsung’s Galaxy rising in share versus Google’s Android
More recently, to combat Android’s weak security and its susceptibility to hacking, Samsung created the Knox security system to be part of its SAFE platform. The Knox system helps alleviate the fear of hacking and makes Samsung devices more attractive to enterprise customers. Although this feature will increase sales of the Android platform, it only accrues value to Samsung, at the direct expense of Google. The development of proprietary software like Knox is a further step away from Android to a completely independent Samsung OS.
Samsung’s March 14th launch of the Galaxy S4 provides the most telling glimpse into the future Google-Samsung relationship. Not only did Samsung release a suite of Samsung specific software like S-Voice, S-Translator, and a Samsung Apps store (replacing functionality currently offered by Google), but at no point during the grandiose release was Google even mentioned as a strategic partner.
High-end smartphones are vital to Samsung. The Korean firm’s handset operating margins sit at approximately 20%, but earnings are heavily skewed towards its flagship devices. The Galaxy line earns 35% margins, while mid-to-low market phones yield margins of only 1-2%. Equally important are the spillover effects from being a smartphone leader. Samsung depends on the brand power gained from the Galaxy line to market and position its other product lines.
History Repeats Itself
Industry consensus suggests Samsung is going to “fork” the Android OS. Forking is a term used to describe when one firm takes an open software platform (such as Android), changes the original code, and adds its own proprietary software on top, effectively creating a new distinct piece of software. The notion of Samsung forking Android should not come as news to Google; the internet giant faced a near identical situation in 2011 with the Kindle Fire and failed to make any strategic preemptive moves.
When Amazon first released the Kindle Fire, it operated on the Android platform. Amazon, however, had no plans to continue using Android and chose to revamp the software to its own specifications. Many Google offerings and services were removed from the tablet, taking with them a valuable source of data. The Kindle Fire now represents 8% of total US tablet market share and has a user base three times greater than any Android tablet; despite this, Google is unable to capitalize on any data from this consumer base.
Google’s Future in the Mobile Industry
Google needs to build a defense to maintain its position in the mobile market should Samsung decide to fork Android. The 2012 acquisition of Motorola provides a perfect hardware partner to build a high-end Google branded phone that can compete against the S4. Rumors of a Motorola X Phone suggest a phone is in the works that gives consumers the ability to customize their hardware. It is rumored to offer integration with Google’s wearable computing offerings, namely Google Glass.
In order to effectively compete with Apple and Samsung in the mainstream market Google will need to target the average consumer, which represents a departure from Google’s historical focus. Consequently, Motorola branding and specifications that appeal to the “techie” market over the average consumer is not the path Google should be taking. Given Google has far greater brand appeal than Motorola, this new phone should deemphasize Motorola’s involvement despite its back end work. The new phone should be branded strictly as the “Chrome Phone” to play up the anticipated future convergence of Android OS and Chrome OS.
Highlighting specifications that appeal mostly to tech conscious consumers will not accomplish Google’s ultimate goal of securing a reliable mobile data pipeline. The Chrome Phone will replace the Nexus line, whose reputation as a “developer phone” and lack of full Google branding limits its mass market appeal.
A key success factor in the mobile industry is having one flagship device. Where Samsung has the Galaxy line and Apple has the iPhone, Google will now have the Chrome Phone. A marketing budget of $1.5B should be dedicated to the release, which exceeds the Galaxy S3’s $1.1B budget and approaches the S4’s anticipated budget. Such a large budget is vital to building hype in the competitive hardware market, and given that consumers are not accustomed to Google hardware, a large effort will be needed to encourage early adoption. Several phones with top-tier specifications have failed to meet sales targets due to unaggressive marketing campaigns, most notably the HTC One X. A $1.5B campaign from Google will help prevent these previous issues.
Since Google’s primary focus is ensuring a pipeline of data collection, the Chrome Phone should be sold at a discount to the iPhone and Galaxy lines. Unlike other phone manufacturers, Google is able to make money off data collection in addition to hardware markup. By entering the high-end market at a mid-level price point, Google immediately establishes itself as a formidable competitor who can subsidize smartphone sales through data monetization. A mid-level price point also conforms to Google’s desire for openness and accessibility in the future of mobile.
Although Google can trace its mobile history back to the founding of OHA, it must realize how dramatically times have changed from 2007. Other than Samsung, OHA is composed of what are now fringe players in the smartphone market. These fringe players – LG, HTC, Sony and the like – will not be pleased about the introduction of a Google branded competing device. But these competitors are effectively powerless and cannot offer any substantial pushback. Ceding to the wishes of these irrelevant players by not aggressively marketing the Chrome Phone’s launch would only serve to further expose Google to the threat of a Samsung fork.
In the long term, the Chrome Phone must drive integration across Google platforms. The Chrome Phone can serve as the focal point from which consumers utilize Google’s services and future hardware. Despite having a suite that includes smartphones, tablets, Google TV, Chrome OS, and Google Glass, Google users do not exhibit the same motivation to remain within the ecosystem as Apple users do. Google has not controlled this ecosystem in the past, allowing hardware manufacturers to put their own tweaks on Google software, thus preventing seamless integration. Google must now use its increased power through the introduction of Chrome Phone to ensure the ecosystem is properly maintained. By doing so, Google can prevent similar vulnerabilities from reoccurring.
Failing to take proactive action has burnt Google before. As Samsung grows to capture an even greater mindshare of consumers and the Android market, the steady stream of data Google is collecting becomes increasingly vulnerable. It’s time to take an asset that is bleeding money – Motorola – and put it to work.
