Unbundling innovation: Samsung, PCs and China

It seems pretty clear now that the Android OEM world is starting to play out pretty much like the PC world. The industry has become unbundled vertically between components, devices, operating system and application software & services. The components are commoditised and OEMs cannot differentiate on software, so they are entering a race to the bottom of cheaper and cheaper and more and more commoditised products, much like the PC industry. 

The funny thing about this is that part of the original promise of Android was that it would allow OEMs to avoid this. Part of the promise was that because Android was open, OEMs would be free to customise it to differentiate their products on top of a common platform. But of course, it hasn't really worked out like that. I think there are a couple of reasons why. 

The first is that 'a common platform that OEMs can differentiate on' is very close to a contradiction in terms. Microsoft never pretended to allow OEMs to change Windows in that sense, and it quickly emerged that if you did change Android in any really important way it was no longer part of the common platform, but a fork. This is what Amazon has done with the Kindle Fire, and Google's reaction (as the sole arbiter of what is nor is not a fork) is that if you do that, you lose access to all Google's own apps, tools and APIs for Android. It wasn't entirely clear 4 and 5 years ago how big a deal that would be - how much of the value of a smartphone operating system would be in those embedded meta-services and cloud services from the platform provider. But now it's apparent that if you don't have those then you're really only selling a featurephone, at least as far as a normal consumer is concerned, and the only companies that have the assets and resources to build those things themselves (outside China, which is another world for Android) are Amazon (perhaps) and Microsoft. 

So, as an Android OEM, you can't practically make fundamental changes to Android anymore than a Windows OEM can make them to Windows. What you can do is to try to add value on top. That hasn't worked either, for several reasons:

  • Most of these companies are simply not good at software and services: the operating structures and skills required are totally different and hard to build
  • Anything that they add, even if it's actually really good, is competing with everything on the app store and everything on the internet. So even if they're good at software and do make (or buy or partner with) something good, it's just another app amongst many. The whole point of open platforms and indeed the internet is permissionless innovation - you don't need the OEM's permission to innovate. Again, how can an OEM differentiate by adding things when a user can add anything they want themselves? 
  • If they do anything cool that requires any sort of third party support they probably won't get it, because the ecosystem effects are at the platform level, not the OEM level. Hardly anyone will support something cool that only works on Samsung Android phones (or only some Samsung phones). 

The general point here is that the differentiation moved from one part of the stack to another (or, perhaps, to a new layer). The OEMs' own software used to be a core part of the purchase decision - that was Nokia's advantage with Series 40. But now that way to differentiate has moved up the stack to a new layer that the OEMs struggle to access - it's controlled by Google.  

There's another parallel here, I think, with what happened to the mobile operators. If you go back to 2000, they were all intensely aware of all the cool stuff that was going to happen with mobile and the internet.  They predicted a great deal of it very accurately, but they thought that they would be doing all of it. And of course what happened was that again, that innovation and differentiation layer got unbundled - it moved up to a new layer at the top of the stack, and the handset OEMs and MNOs were equally unable to access those services. Just like the OEMs:

  • The MNOs were structurally bad at making services
  • Even if they were good those services were just one amongst many
  • The network effects for these services ran across the whole internet, not just their customers. 

That is, MNOs tend to be bad at innovation in internet services, but even if they aren't, it isn't their place to provide it. It isn't their place in the stack to make a great video sharing site or a cool photo messaging app, even if they could. The analogy I often use in this case is that for an MNO to get into apps and content is like a municipal water company deciding to get into the soda business - because it knows water, and has trucks, and customers trust its brand. Even if it managed to come up with a great soda, it would still be just another can of soda amongst many. (Continuing the analogy, of course, it also makes little sense for soda companies to think they can get into the municipal water business - nor for tech companies to think they're going to disrupt mobile operators). 

When you unbundle an industry, you get new and different types of innovation in different layers of the stack. The skills you had in the bundled world may well still apply in the layer you find yourself in. Hence Samsung carries on doing interesting and impressive things in components, and can innovate up to a point in handsets, with things like phablets, so long as they do not depend on concessions from other parts of the stack. Equally, for example, Dell created an entirely new type of PC company - the PC company as a highly specialised logistics business - without differentiating at the operating system layer at all. 

But what's happened for PCs and smartphones and, to a large extent, mobile networks is that it's that top layer of the stack, that the PC and Android OEMs  and operators struggle to play in, that's where most of the differentiation happens. That's the stuff that makes the difference between a commodity and something unique. This is obviously something of a wrench. After all, especially for the phone companies and mobile operators, this is what they always felt they should be doing, and now other people are doing it instead, free-riding on top of their work and their investment. 

Samsung, Apple and Microsoft are all strong in two layers: Samsung in components and devices, Apple in devices and operating systems and Microsoft in operating systems and application software. Each of these companies has cross-leveraged these adjacent strengths to create better products and a stronger market position. Samsung has used the scale of the component business and access to those components to drive the devices business and vice versa, despite failing, mostly, to create compelling software differentiation. This leveraging of scale, combined with some great execution, has taken it to at least half of the total Android market. 

The problem is that Samsung is increasingly competing with another sort of scale effect - it is competing with the entire Shenzhen ecosystem. Before, it was competing with individual companies (many of which happened to use that ecosystem), and like Nokia before it was fortunate in the relative weakness of most of its competitors. As for Nokia, that luck was bound to run out. Now Samsung is starting to face competition with new companies who are finding ways to build new types of handset businesses on top of that ecosystem - taking that ecosystem and using it to unbundle Samsung.

The company that everyone talks about here is Xiaomi, which has created the skills to build both good services and software and good handsets. Xiaomi has faced the fork problem by working out how to dance right up to the edge without going over - Hugo Barra described it as a 'compatible fork'. Rather than turning Android into a fork, it has, so to speak, polished it, adding features and services without breaking anything. And so it has created real differentiation at the operating system layer without losing access to Google services, which its devices outside China all use. 

But there are lots and lots of other interesting Android companies unbundling, both within the price range, with some attacking the mid range and there the low end at under $100, and geographically, with companies like Micromax, Karbonn or Blu or Wiko peeling off particular geographies. In effect, this is the Dell innovation - not trying to get into the other parts of the stack (though Dell has moved into other businesses), but at being really really good at your own part. 

This also reminds me a little of Facebook. Facebook's integrated social platform model has been unbundled by mobile, with the social graph that it owns on the desktop being replaced by the smartphone itself as a social platform that all social apps can plug into. Hence, there have been dozens of new and interesting services peeling off parts of the use case or creating new ones. Making good services in this space does not require a totally different type of company, in the way that making good services and running a mobile network require different types of companies, and Facebook's 'constellation' approach to unbundling its apps has resulted in some perfectly good products, but so far none of them has risen above the status of 'just another social app' - they're all just another can of soda. 

Android instability

If you were a PC OEM from, say, 1990 to 2010, you operated in a very clear ecosystem. You outsourced much of the innovation to Microsoft and Intel. You knew exactly what WinTel were doing, both because their roadmaps for the next few years were actually public and because Microsoft and Intel had very clear and widely understood strategies. Moreover, the core, fundamental strategies of OEMs, Intel and Microsoft were pretty much aligned. Everyone wanted more PCs to be bought, and preferably a good number that were high-end and high-margin. Intel, Microsoft and CloneCo all lived for the same things. CloneCo didn't necessarily make great margins (and eventually got killed by Dell, perhaps), but it knew what the game was. 

The Android ecosystem today is superficially similar to the PC ecosystem, but I'd suggest that the clarity and alignment of interests of the PC ecosystem isn't present in anything like the same way. As an Android OEM you have very little idea what Android will be in 3 years - partly because Google itself may not have a fully-formed idea. There certainly aren't public roadmaps stretching out years in advance. 

It's also questionable how much alignment of interest there is. Google certainly wants Webkit everywhere, and arguable Android everywhere (or, more precisely, Google Plus everywhere). But that doesn't translate to a burning hunger for an aggressive phone replacement rate at high prices. Indeed, Google Play Services reduces Google's interest in device replacement as a way to drive service penetration. As an Android OEM, your ecosystem creator doesn't benefit directly from the health of your industry. A healthy PC market was Microsoft's driving objective - 'A computer on every desk and in every home'. That's not quite the case for Google and the sales of Android smartphones - they're reach, and a means to an end, but not the reason why Google exists. 

Next, it's not clear what a sustainable position for an Android OEM looks like. All the brands except Samsung are sub-scale and failing, and while Samsung looks dominant it is clearly feeling paranoid: the growth of the Chinese Android OEMs outside China is a huge question. Lenovo has made its first move by buying Motorola but the real story is whether 2, 10 or 100 others follow it, and if so how. 

Finally, Google's control of Android itself is a question. Amazon forked it, but with limited broader effects. Almost all Android in China lacks Google services but then Google is largely absent from China anyway. The ways that forks of Android might become relevant outside China (and Google's tools for preventing this) are complex and a topic for another post, but we can't rule this out. Indeed, a lot of the most interesting ecosystem innovation is being done on top of Android rather than as a would-be competitor to it. 

On one level, then, the smartphone platforms wars are over - iOS and Android both won. But actually, nothing is finished - we just move onto new questions. 

A note on the high end

Samsung had an investor day last week - the first for many years. It was extremely low on information about its mobile device business, but one figure did catch my eye - a target of 100m unit sales of combined Galaxy S and Note devices. 

Something that people often don't realise, especially in the USA, where even high-end phones are free, is that high-end Android phones are not what are outselling the iPhone. It's the mid and low end that's making up all the volume. That 100m number is a good illustration - it makes up less than a third of the Android phones that Samsung will sell this year. The other two thirds are Android phones other than the S2, 3 & 4, that sell at much cheaper prices. 

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Scale and polarisation in mobile

There are lots of ways to look at the global handset industry, but the polarisation evident in this chart is pretty compelling. Not shown - the hundreds of 'other' manufacturers, mostly in China.

The CFO of Qualcomm recently described the industry as a barbell - Apple and Samsung at one end, then the smaller and mostly sub-scale players (though some, such as Sony, are showing signs of increased health, albeit from a low base), and then at the other end, invisible, the Chinese. 

As an aside, this also illustrates the way that Apple has become so cyclical that it's really only the December quarter that gives a good directional steer.  

The state of mobile, Q2 2013

This chart is an attempt to capture the key dynamics in the global mobile business. It shows unit volume, revenue and ASP (average selling price) for the key components of the tablet and mobile phone industries. There's a pretty clear picture:

  • Samsung dominates by volume and leads on revenue
  • 'Other' Android is getting very big (this includes Lenovo etc, of course)
  • Apple continues to sell at much higher prices than anyone else
  • The iPad continues to lead on revenue but probably not on volume (and if it does, it won't be for much longer)

Note that unless explicitly stated otherwise, these are for all handset sales, not just 'smartphones'. Tablets are shown separately. 

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This data contains a fair few assumptions, given the somewhat imperfect nature of disclosure in the industry today:

  • Apple, Nokia and Blackberry disclose all three numbers
  • HTC, Motorola, Sony and LG give handset revenue
  • LG and Sony give smartphone units
  • Samsung gives revenue for a unit that includes handsets, tablets and PCs, but these are pretty small
  • Google gives enough data to estimate total quarterly Android activations and Android tablet activations
  • However, perhaps 80% of Android devices sold in China have no Google services, do not activate with Google and are not included in activation numbers - I've estimated these separately, both for phones and tablets
  • Chinese tablets are - tough - to estimate: they make up half of the 'other tablets' entry and there's a pretty big margin of error on that one 
  • Amazon says nothing at all about the Kindle Fire
  • Windows tablet sales are too small to move the series on this chart
  • Most of the unit data is 'shipped' rather than 'sold', but except for egregious flops this doesn't actually make much difference on this scale, and the Android activations numbers do of course relate to sales.  
  • Etcetera

Tech innovation in TV

With Boxee being bought by Samsung at (as rumour has it) not much more than the capital invested, it's worth revisiting Steve Jobs' extremely succinct 2010 explanation of why it's so hard for any external company to innovate in this market. It's a route to market issue, not a technology or vision issue. 

And no, this acquisition doesn't mean Samsung will (or rather should) get into the TV content business.  

Addressable markets for high-end phones

There are all sorts of ways to estimate the addressable market for a high-end phone like the iPhone. One way is to look at price sensitivity, the propensity of lower income groups to spend on expensive entertainment products and how that might be affected by the increasing capabilities of cheaper devices. Another is to look at the mobile operators that do and do not actually offer the iPhone, which gives you a figure for people who cannot in fact buy one, at least on subsidy, even if they want to (assuming they're not willing to switch operator). 

However, it seems to me that the central issue in sales of the iPhone and other high-end models is the availability of subsidies themselves. After all, if a phone is good enough for consumers to want it and the OEM has the scale and budget to provide it (an issue for some) then distribution is just execution and time, not a fundamental constraint. Ability to pay, too, is a moving target: people substitute spending for products they really want, and $600 isn't that much money over two years for a large proportion of the world's population. 

So actually, the real questions are the big numbers: how many people are getting subsidies? How many are buying phones? 

Hence, my first chart shows just how the smartphone install base compares to the total global population. 

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There were about 5.2bn adults on earth at the end of 2012. Of those, around 3.2bn had mobile connections, though not necessarily phones (some people have a SIM but no phone, and many have multiple SIMs, which is why the number of connections is well over 6bn). Within that, roughly 1.1bn had 'smartphones' at the end of 2012, of which around 900m ran either the iOS or Android versions of Unix. (As an aside, it is pretty striking that almost a fifth of the earth's adult population has a Unix box in their pocket.)

So how does that relate to contracts, and hence subsidies? According to my old colleague at The Mobile World, there were around 1.6bn contracts in place at the end of 2012. 

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For now, the overall smartphone base remains below the contract base, though it is growing fast. But the non-contract portion of the world's population is much bigger. If I turn the chart upside-down the point is clearer. 

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At the end of 2012, 2bn adults had yet to buy a mobile connection of any kind, and another 1.6bn were on prepay and not eligible to get subsidies. It doesn't matter how many operators Apple or Samsung puts on distribution: those people are not going to buy a $600 phone.

However, that leaves about 1.6bn who might. 

HTC and Samsung

It should be pretty obvious that Samsung (or even just Samsung Electronics) is a much larger company than HTC, with much more financial firepower. But it's interesting to look at some of the ways that scale affects things. Marketing is a good example. 

Both companies disclose a 'sales and marketing' line. For Samsung this includes activities for the TV and domestic appliance divisions, but the way the spending has grown in recent years suggests that the great majority of the spending is for mobile - and of course the brand is the same anyway, so advertising for TVs will also bleed across to phones.

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Where is this money going? Well, Samsung discloses a split in the 'sales and marketing' line - around 40% is advertising and the rest is 'sales promotion expenses' - a lot of which is sales commissions. 

In Q4 2012 Samsung's budget was 13 times HTC's. Samsung hasn't disclosed the Q1 number yet, but if it dropped to, say, $2.5bn in Q1, the same proportionate shift as at the beginning of 2012, it would be about 19 times bigger. It's actually a little hard to see given the scale, but HTC's budget is down 40% year on year, to just $130m, a tiny amount. And given their operating profit was zero in Q1, they can't afford to spend much more.

In the handset market today, having a lovely product is necessary but insufficient. This chart ought to show why.

Incidentally, Apple doesn't break out a sales and marketing line (it only gives the advertising spend): in 2012 Apple spent about 25% as much as Samsung Electronics directly on advertising, some of which was obviously for iPads as well. However, it has contracts requiring mobile operators to spend money on advertising as well, so this isn't a direct comparison.