Phase Transitions and the Googlephone

Baruch keeps thinking about Apple and what it’s done to mobile phones. Call him obsessed if you will, but it is also his job to think about it, and there’s good money to be made if you get it right. You may recall his last post on the subject, that Apple has become wholly dominant in the mobile internet and smartphone space. What’s struck him recently is how few of the intelligent analysts and counterparties he talks to actually agree with him on what seems even to generalists utterly obvious. Lots of them still think it’s a good idea to push other smartphone stocks, like PALM or RIMM, which if Baruch is right is a very efficient way to lose money, inferior only to piling it up in big mound and setting light to it.

Why people can think this way was a mystery to Baruch, until he made the realisation that the phase transition in the handset market is not yet evident to them; they still think the handset market resides in Mediocristan, as opposed to the Extremistan regime it has most likely become. They haven’t been reading their Taleb.

It’s a forgiveable error; again, Mediocristan is a fictional place where standard distributions, bell curves, rule, where market shares are shared between players, and where tall poppies get their heads cut off. Hardware and appliance markets have traditionally exhibited these characteristics. Look at cars, or blenders; lots of players can make a decent living selling blenders. Similarly, until now, 4 or 5 names shared out the vast majority of goodies in mobile telephones. Maximum market shares seemed to be limited at 30%-40%; losing or gaining 10 points of share took years. Over long periods those gains or losses would, unless something had gone very wrong with one of the players, tend to mean revert. It seemed a fast, dynamic sector at the time, but really, it wasn’t.

Now, software or application markets show us entirely different characteristics, those of Extremistan, where rapidly evolving monopolies and duopolies are much more common. SAP and Oracle own the enterprise software space. Adobe owns documents. Google owns search. Microsoft still owns PC operating systems and office software suites. Autonomy owns unstructured data mining, etc etc. In most of these cases, market shares continue to consolidate. In fact, the example of PCs is illustrative; the hardware aspects of it are Mediocristan-like, shared between HP, Dell, Acer and a few others, while Extremistani Microsoft does almost all the software, and Google does almost all the cloudy, web based stuff.

Apple’s achievement has been to shift the focus of the high-end handset market from voice to apps and browsing. Any old hardware would do for voice and SMS. So vendors added froufrou to differentiate themselves and keep ASPs up. It was the battle of the specs: multi-megapixel cameras, thin form factors, FM radios, MP3 music players, and most uselessly, “express yourself” multi coloured casings. That’s finished, though the Sony-Ericssons of this world pretend it hasn’t; now it is how nicely your phone can email, surf the web, and most of all, how rich and easy is the ecosystem of applications, that determines whether people buy your product or not. That’s software; precisely the type of market where monopolies or duopolies emerge.

For hardware-focused analysts, it’s hard to accept that their reliably mediocre handset market has been transferred to Extremistan. Baruch’s own thoughts on the subject over the past 2 years  seem to have followed the traditional stages of grief, from denial to anger, depression, and, with this post, final acceptance*. Many of his peers are still stuck on denial. When pushed, they say things crossly to him like, “well, if you really think no-one’s going to properly compete with Apple, you shouldn’t be owning anything in the space.”  Ahem.

The fact that it IS happening is the only reasonable explanation I can come up with for the otherwise obviously insane step Google just took, which was to leak to the WSJ their upcoming “Googlephone“, a Google-branded Android phone made by HTC. It’s hard to know what they’re doing here; are they trying an end run around the operators? Apple tried that with iPhone v. 1.0 and failed, and had to reset their strategy for iPhone 2.0. Are they trying to spur their ecosystem into greater efforts? Frankly demoralisation is an equally likely response by e.g. Motorola, on finding out their key software ally just became a competitor.  They could lose interest in the platform. It’s like Microsoft, in 1990, deciding to make its own branded PC to compete with Compaq and HP. Would that not encourage them to, I don’t know, try Linux or something? Dust off the old Amiga OS? Or diversify into blenders?

Google is the epitome of a company used to Extremistan-like environments; compared to how things worked in the old days in handsets, Android adoption has been excellent. But in Extremistan it’s not enough. Android app catalogues are neglected, and the best ones come from Google. It’s forced to write the apps itself because independent developers have limited resources; having to tailor apps for the different hardware specifications of all the different Android phones is too annoying, the ecosystem too fragmented. Much better to write for iPhone first. Most people still don’t know what an Android is or does; the most successful Android, MOTO DROID was launched in a blizzard of marketing and sold a respectable 800k+ in a month; but Google must suspect the loyalty of Verizon to the platform, and most everyone knows a Verizon iPhone is coming down the pipe in mid-2010.

No, Google know they need to do something, and the endgame may be rapidly approaching. Last week PALM reported, and the stock tanked; they basically admitted they were embarking on a death-or-glory spending spree, which if successful might see them make a bit of money for their investors, but probably not much. The downside of course is zero; Baruch has a hard time getting his PALM model to produce a positive result.** RIM numbers came out on the same day; they did better, and are making great headway expanding distribution overseas. But their core US market was flat for them, which supposedly should be expanding 30% a year — not a good augury for when the first flush of geographic expansion ends.

2010 is looking like a crunch year for smartphones, and for many vendors “crunch” may be more than a figurative description.

* many of the commenters on this website were far ahead of Baruch on this — Cash, Comrade, Andrew, anon, Ramster and the rest of you, aren’t you clever. Grr.

** yeah go buy puts on PALM; great idea down here with like 50% of the shares shorted. Or maybe not, who knows. Whatever, please don’t use Baruch as an investment advisor. He’s just trying to look good (and mostly, not succeeding); he has no interest in making you money.

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8 responses to “Phase Transitions and the Googlephone

  1. Lets just say for kicks that Apple controlled 70% of the worldwide smartphone market in the next 5 years just like the do the mp3 market? What would the stock be worth modeled on that?

  2. Its not just the iPhone – its the iPod Touch as well that you should consider. Among my daughter’s 6th grade peers, iTunes gift cards are the currency of the realm. They all have iPod Touches. After I bought her one, I liked it so much that I bought one for myself. As far as I can see it has the best parts of the iPhone but lacks the phone itself.

  3. Let’s assume whatever Google does with the phone is bottom line close enough to break even profitability wise. Does Google have an ability to make more money in search because I have a Googlephone instead of an iPhone and perhaps use a few Google apps as well? Or is this really a fear of a non-open playing field, ala the FCC spectrum auction. I can certainly understand the fear factor, considering what happened to Netscape. Fortunately it appears Microsoft is being pushed out of the market, definitely with some help from Android on VZ. My assumption is that the iPhone will be sufficiently “neutral” for Google, but I’m interested in knowing what other folks think. I agree 2010 will be a very interesting year…thanks for your writeup.

  4. I don’t know, Jay. Apple’s not a stock I actually cover (which is why I don’t have a problem writing lots of guff about it). I would guess “more” is the answer. But some/lots of it is surely baked in, don’t you think?

    That is interesting, Rangachari. Similarly I was struck that my kids (much younger than yours) sort of knew how to work an iPhone/iTouch when they were shown one. When I see someone with an Android (no-one I know has one) I will see if they can work that one out as well.

  5. Another interesting dynamic at work within telecom industry is the presence of new antitrust economists in the Obama administration. Carl Shapiro wrote the book on network effect economics (the economics of Extremistan?) with Hal Varian in the 1990s. He and his counterpart at the FTC may have some unpleasant surprises for companies with lots of control over platforms.

    Interesting times…

  6. Michael I don’t see that happening. It’s silicon valley money that got the democrats into the white house and it’s silicon valley money that will keep them there. Airlines though are another matter entirely as an example of the diffference.

  7. That the state transition in the mobile market has now happened (obvious to everyone except handset analysts), as we talked about in June last year is pretty much a given (http://ultimibarbarorum.com/2008/06/12/operational-leverage/#comments).

    However, while struggling to catch up with this change to the mobile computing platform, the non-technical guys have missed the point that the mobile market for Apple and Google is not an end in itself but is a proxy to the the next stage of computing which is revenue from and control over data portability/processing/storage and access.

    As these smart devices progress, the next stages will be characterised by the more pronounced blurring of online and local (your own PC/Mobile/TV) data requirements.

    The Google move is not so strange when you realise that the mobile device market itself is not really the important bit (especially if they can reduce the importance of the access device, as happened to the PC). While it is worth a reasonable amount of money now, the real goal is the future control/influence of the pinch points of access to and applications on that data-cloud type environment.

    With that in mind you may find that Google are prepared to run a large loss in this area for as long as it takes, irrespective as to whether the analysts get it or not.

    This is even more vital to Google as a lot of the Android licencees do not get this and are using it as a way of still trying to sell through their existing (and dying) business model. If I was Google I would also not care about my effect on the the handset manufacturers as they will not be around in a few years unless they change dramatically in their outlook.

    I think Google has realised that if Apple get too far in front it will give them a very strong influencing position in the future which will be a big mountain to climb if it becomes too entrenched. I suppose they thought that licensing to the phone guys would help out with this but many of the handset companies just seem to be fumbling around with band-aids to their strategies while Apple is stomping them to death.

    In a wider sense Google are trying to push the network is the computer thing with online apps etc so your data is not tied to the device and Google provide all your app needs. In infrastructure terms they have a huge lead in the remote data arena.

    Apple are seeing the same developments but are trying to consolidate in the area they are strong in ( which are the device types you own PC/TV/Phone etc). Ensuring these are from the same supplier, with the same apps gives you seamless interaction and Apple greater control as the gatekeeper of the software to access this stuff.

    Once you accept this perspective of looking constantly at the next change as the focus of software developers, things make a lot more sense.

    The business guys are seemingly always extrapolating from the car that last ran over them rather than looking down the road to what is coming. (I better be careful or I will start quoting Taleb here)

  8. McNamee was wrong on timing, but hey so was the Coffee Table Test. The point is valid, no?

    Short product cycles will pull the market back to a Gaussian world, no? Consumer software looks much less Extremistani than enterprise.

    “You know the beautiful thing: June 29, 2009, is the two- year anniversary of the first shipment of the iPhone,” McNamee said today in an interview in San Francisco. “Not one of those people will still be using an iPhone a month later.”