Who will disrupt Google and Facebook?

Driving home from a breakfast meeting this morning, I got to wondering who is going to disrupt Google — and how soon.

Those of us who teach strategy know how all about examples of new entrants commoditizing and destroying the revenue models and profit sanctuaries of long-stable, long-established businesses. (The term “disruptive innovation” seems most convenient here, despite the recent controversy over the original evidence of same). Here are a few examples.

• Craigslist and various Internet portals (such as Google and Yahoo) destroyed newspapers — aided by the latter’s poor business models, some unfortunately inaccurate assumptions about the supply (and thus price) of Internet advertising and key tactical errors along the way.
• Two entrepreneurs created GrandCentral, a (temporarily) free telephone answering and forwarding service, and in 2007 sold it to Google (where it is now Google Voice). It now has voicemail transcripts and other improvements but is still free. Thousands of small companies and nonprofits (including my own) use it in lieu of an answering service.
• I learned how to use Google Forms from my friend Mako Hill (and his need to run the OUI conference with limited cash and volunteer resources). Now I use it for most things that other people use SurveyMonkey for.

So the question I mulled over was, who will disrupt Google? Facebook would like to take business away from Google, but it’s not through cost reduction or elimination of revenues. Rather, Facebook imagines that its socially embedded ads will be more valuable than Google’s search context-specific ads.

Instead, I find Facebook ads creepy and sometimes invasive of my privacy, particularly when Amazon ads show up for a book that I looked at (but ruled out buying) five minutes earlier. (Apparent Amazon is not alone). I am appalled at what would happen if I had looked at a socially undesirable product on Amazon (sex toys, a book on bombing government buildings) — even though I know that anonymous browsing without cookies would allow me to ask a question (if not make a purchase) without leaving digital breadcrumbs.

Then when I got home, I saw this wonderful article by Andrew Orlowski of The Register (who I mainly know from his insightful analysis of mobile phone platform wars). One passage (emphasis mine) touched on the same theme:

'Dear Daddy...' Max Zuckerberg’s Letter back to her Father
What do you mean, I can't get off Facebook?

2 Dec 2015 at 13:02, As told to Andrew Orlowski

Comment Yesterday Mark Zuckberg accompanied the birth of his first child, a daughter Max, with a long open letter.

Thanks to the miracle of modern technology, we've found what Max might write back, and we're sharing it with you:

Dear Daddy

Thank you for the letter that your PR and public policy team wrote to mark my Birth, and sent to every news outlet in the World. Most Daddies wouldn’t do this. Heck, most Daddies don’t even have PR and public policy team, and those that do wouldn’t use to leverage a private family event!

That’s why you Daddy, are so special.

You write: "We want you to grow up in a world better than ours today."

Well, duh!

If I discovered that my well-educated billionaire parents wanted me to grow up in a world that’s worse than ours today, I’d already have crawled my way to a phone booth and dialled 911 to alert the authorities.

That goes for "a world without suffering from disease” too. Wow. Where do you get this stuff, Daddy? I heard more original ideas when I was a single cell blastula!

You also write:

"Technological progress in every field means your life should be dramatically better than ours today."

I’d like to think so too, Daddy, but there’s this thing that’s bothering me.

It's called Facebook.

And not just Facebook, it’s the way Silicon Valley companies like yours pile up huge wealth by destroying value in every other part of the economy, as if technological progress were a zero sum game. It’s the way you strip-mine individuals so they have no ability to be autonomous economic agents, owning and trading the stuff we make, so all we have to live on is some feudal digital plantation - and we have to be grateful for it. It's the way some Valley firms place themselves above the law and try to block the work of elected officials who want to defend human rights.

Not you of course, Daddy. Just some of your friends.

I mean, come on. There's a lot to teach children in this modern world I've just been born into. But one thing we've got to learn is that just because you can do something, it's not necessarily morally acceptable to do it. Who's going to teach me that in Silicon Valley?

And Daddy. Connecting people all over the world through an internet website is very cool idea indeed. But it's not that cool or original. It’s as if the guy who invented the bottle-opener wrote a plan to become Emperor of the World. Like, "Remind me who you are again?"

I think that’s pretty weird already. And I’m only one day old!

Well if there’s any of the economy left by the time I graduate, perhaps my generation will be a bit less selfish than yours, Daddy, and we can teach you about it.
…
Well, I’m kinda tired writing all that. It’s time for nap. Just remember when you’re burping me, do it over your shoulder, that way I won’t puke all down your front.

Your loving baby daughter,

Max

In the Google (and now Facebook) case, I thought about Microsoft. They were a one trick pony that was handed a monopoly in operating systems (and used that to build another one in business productivity apps) that they exploited to the maximum degree possible. But a) they lacked the ability to create new compelling products and business models and b) everybody distrusted them and thus were wary of providing them new monopolies, no matter how good their technology.

So at some point, the shoe will be on the other foot: what happens when Google and Facebook have their profit sanctuaries destroyed? Google — now Alphabet — appears headed towards becoming a diversified technology conglomerate. It has worked (so far) for Hitachi and Samsung, but not for HP or Sony. Thus far, it appears that Apple and IBM have been the masters of re-invention: will the new kings of Silicon Valley be able to replicate such feats?

For once, LG may beat Samsung

Samsung has been touting the latest strategy for Tizen — this time as an integrated OS for its smart TVs. It’s earned dozens of news stories this month, all tied to its promotional efforts for this week’s CES show in Las Vegas.

Samsung has always been better at announcing and publicizing Tizen strategies than it has been at executing on them. It did not skimp on the grandiloquent predictions when its original incarnation (then called Bada) was announced in November 2009:

Samsung Launches Open Mobile Platform: Samsung bada – The Next Wave Of The Mobile Industry
November 10, 2009
Samsung Electronics Co. Ltd., a leading mobile phone provider, today announced the launch of its own open mobile platform, Samsung bada [bada] in December. This new addition to Samsung's mobile ecosystem enables developers to create applications for millions of new Samsung mobile phones, and consumers to enjoy a fun and diverse mobile experience.

In order to build a rich smartphone experience accessible to a wider range of consumers across the world, Samsung brings bada, a new platform with a variety of mobile applications and content.
…
Based on Samsung's experience in developing previous proprietary platforms on Samsung mobile phones, Samsung can create the new platform and provide opportunities for developers. Samsung bada is also simple for developers to use, meaning it's one of the most developer-friendly environments available, particularly in the area of applications using Web services. Lastly, bada's ground-breaking User Interface (UI) can be transferred into a sophisticated and attractive UI design for developers.

Samsung will be able to expand the range of choices for mobile phone users to enjoy the smartphone experiences. By adopting Samsung bada, users will be able to easily enjoy various applications on their mobile.

Encouraged by Samsung, one analyst predicted that Tizen would make up “half of its portfolio by 2012.”

Instead, (according GSM Arena) only 11 bada models ever shipped — out of more than 3200 models during the past 5 years — before bada was discontinued in favor of Tizen — a merger of bada and the Intel- and Nokia-flavored mobile Linuxes (among others).

Samsung announced its first Tizen phone — the Samsung Z  — June of 2014. A defeatured version of the Galaxy S5, it debuted not in Korea — or North America or Europe — but in Russia, suggesting the company did not think it could compete head to head with the latest Android and iOS phones. In fact, it was even ready for a third world BRIC country: the release was cancelled due to a lack of applications.

At CES this week, Samsung announced that Tizen would jump species — from its viral reservoir in rare smartphones and smartwatches — and become the only OS it uses for its smart TVs. I had three reactions.

First, so what? Yes, as the leading TV vendor Samsung can push out lots of copies of Tizen. But does anyone care what OS is in their VCR, DVR, Blu-ray, TV or home stereo? (I care about the OS in my car stereo — due to cellphone compatibility — but that’s a story for another time.)

Second, Samsung is saying: “let’s ship a platform in a product category where no one cares about app availability.” In other words, it may never win developer support for Tizen — and thus a large assortment of apps — but on TVs, who cares?

Finally, while Tizen frees Samsung from dependence on the evil Google, is shipping Tizen an asset for Samsung — or a liability?

Under the hood, Tizen has a very robust Linux, reflecting bada’s 2011 merger with MeeGo, which in turn built upon years of work by Nokia (with Maemo) and Intel (with its Maemo fork called Moblin). (It also included the failed Linux Mobile standard, LiMo).

However, a robust OS under the hood means nothing if it has a clunky UI. Exhibit A is the Symbian OS with Nokia’s aged S60 UI; Exhibits B-Z are every incarnation of desktop Linux known to mankind.

Which brings me to the dark horse: LG. I hadn’t noticed, but two years ago LG bought webOS, the failed Palm smartphone OS that HP owned for three years before dumping it. This week LG announced it’s using webOS for its own TVs.

Almost six years ago, webOS was a really good smartphone OS. But despite Palm’s efforts to double-down on its modern OS, it wasn’t enough to save the company. Now, webOS has a $100+ billion/year company behind it — and unlike with OS — a large volume of shipping products where it can run.

With a product strategy that usually consists of copying Samsung — much like Panasonic copied all its Japanese rivals — LG is rarely thought of as an innovative company. But here, instead of copying Samsung by developing its own lousy embedded OS, it bought a good one.

Again, will it matter? Will the TV OS matter more than screen size, brightness or — most importantly for a commodity product — price? As a former software guy, I want software to matter in providing differentiation. But I’m not going to bet even one dollar of our youngest’s college fund on it.

Retailers' Hobson's choice: crushed by Amazon or exploited by Google

It’s no secret that during the e-commerce era, the local (and even chain) retailer has lost its hold over local customers — particularly in the face of an ever-expanding variety of online merchandise, first from Amazon and later from the clicks-and-mortar chain retailers such as Target and Wal-Mart.

Meanwhile, the tyranny of the local newspaper has been replaced by the tyranny of the search engines (i.e. Google) in controlling the ability of retailers to get their message to potential customers.

Now the Wall Street Journal reports that retailers are facing a Hobson’s choice of being exploited by Google to avoid being crushed by Amazon. (Merriam-Webster defines a Hobson‘s choice as “the necessity of accepting one of two or more equally objectionable alternatives”).

The report says that to capture more product search — advertising and purchases — Google is testing a “buy” button for its search results to reduce the number of searches that begin on Amazon:

In the third quarter, 39% of U.S. online shoppers began researching their purchases on Amazon and only 11% started on search engines like Google, according to Forrester Research . That’s a reversal from 2009, when 24% started on search engines and 18% on Amazon.
…
“Amazon is increasingly running away with online retail in North America, which poses a huge problem for Google,” said Jeremy Levine, an e-commerce investor at Bessemer Venture Partners. “Google has to get in front of this and create a reasonable alternative.”

That Google chose to fight back is not surprising, nor is it surprising that it did so without consulting retailers. Given its data-driven culture, it’s also not surprising that it ran a live experiment. However, the nature of the experiment alarmed some retailers:

Retailers’ concerns about Google’s initiative were heightened in November when digital-marketing agency RKG spotted an unannounced Google test. Google users searching for “anthropologie,” the women’s clothing retailer owned by Urban Outfitters Inc., were also shown a link to a Google Shopping page with dozens of the retailer’s product ads. Anthropologie didn’t give its permission, according to a person familiar with the matter.

Or as search engine guru Larry Kim explained:

Is Google Shopping Becoming A Competitor To Retailers?

Based on this test, it would appear that's a real possibility.

Essentially, this would cut out the middleman and drive searchers to make their purchasing decisions within Google Shopping. It adds competition to what began as a branded search – rather than being presented with David Yurman rings for sale by David Yurman, the searcher sees David Yurman rings for sale at Nordstrom, Bloomingdale's and other retail sites.

If Google adopts this test as a permanent feature, it has the potential to drive up CPC's for branded search terms, as people searching for a particular type of product from a specific brand will now be presented with competitor options, as well.

Further, users can do comparison shopping right within Google Shopping, without having to go the retailers’ websites, whether they were searching for a specific retailer/brand or not. It’s another example of Google stealing traffic from your website, like they do with Knowledge Graph and vertical results like weather and flight comparisons.

This could be a welcome change for searchers; this is why Google runs all these tests. But advertisers may be annoyed to learn that searches on their brand name are being used to drive traffic to Google Shopping. … As for advertisers, I’m pretty sure they won't appreciate Google creating competition for them where it didn't exist before.

In this regard, Google is seeking revenue growth by taking traffic from those who created the content it indexed. It doesn’t have to integrate to generate the content or be able to fulfill orders, but instead can control the eyeballs (selling more ads and having more stickiness) while commoditizing retailers.

So in a fight for Total World Domination (or at least North American retail domination), Google will take away visibility and revenue from its most profitable customers.

Why does Google do this? Because it can. It’s not quite a monopoly, but it’s almost without viable competition: in the US, it has a 3:1 market share lead over its nearest competitor on PCs, and a 5:1 lead in mobile. In Europe, it has a nearly 10:1 lead, which is prompting calls for competition authorities to end its vertical integration.

The web brings a scale to retailing that never existing in the turn of the century (or Calvin Coolidge) Main Street USA era. Local retailers (and their commercial landlords) will continue to pay the price.

Is Samsung the next Sony or next Apple?

Tonight I ended another quarter teaching MBA again at my alma mater, the second time teaching IT innovation strategy this year. There isn’t a great fit of the topic to my current employer, so it’s nice to be able to moonlight (with permission) to revisit the course I created at UCI more than 13 years ago.

The students did a number of final projects, and since I’ve been too swamped to blog here (while rarely blogging at my academic blog) — I thought I’d share a few observations here.

One topic that hit me near the end of the last class is that Apple sort of looks like the next Sony. Sony was the great consumer electronics innovator of the 1960s through the 1980s (Trinitron, Walkman) that failed to keep up its innovation as the rate of technological change and is now losing money badly in a commodity business. So with Steve Jobs gone, I have been wondering if Apple will also slow its rate of innovation and become an undifferentiated premium producer in a commodity business.

But my students suggest that however quickly Apple becomes a commodity producer, Samsung is getting their first. 2014 has brought various headlines about how Samsung’s smartphone market leadership is producing losses not cash cows.

By offering slightly nicer Android phones, Samsung is competing within a standard rather than between standards. So while Americans will pay a premium for minor improvements, developing country Android buyers are quite happy to buy Xiaomi, ZTE, Huawei, or some other generic brand.

Samsung does compete in some capital-intensive markets with high entry barriers, but (as with the DRAM of the 1980s) such businesses are prone to commodity price wars. Samsung’s attempt to create unique technology (notably Tizen) has failed: they are a long way from being the next Apple. It has a high rate of R&D spending but not a high rate of R&D outcomes.

Quoting from Geoff Moore’s book (a required text), the students recommend that Samsung compete on integration abilities. I think it’s a plausible idea (if they can ever learn to do UI and software) — they have an unprecedented scope of products, and so if anyone (beyond Apple) has the opportunity to do this, they do.

One thing that is clear: Apple is not the next Sony — yet. And this gives me a chance to quote from a newspaper clipping that I set aside a month ago. Here is an excerpt of an interview with CEO Tim Cook:

MR. [Gerard] BAKER: I want to ask about some of the broader strategic questions for Apple. This phenomenally successful iPhone, which continues to churn out extraordinary profits. You’ve got a very high margin, relatively low volume in terms of total share of the smartphone market.

Now you’re about 15%, 16% globally of the smartphone market. That model has been compared to the Mac versus PC model of old. You have these beautiful devices, which you were first with, which people adopted very, very quickly, but which were a smaller and smaller share of the market.

In the end, the Windows model blew away the Mac, in terms of market share. Is that a risk here?
MR. COOK: I don’t think all market share is created equal. Our objective has never been to make the most. We’ve always been about making the best.

The analogy to the Mac isn’t a good one. It’s clear when you look back what was happening in terms of the Mac platform was there weren’t enough apps on the Mac platform. Customers began to leave, because there weren’t enough apps. Look at iPhone and iPad. I get more customer notes than any CEO alive, I’m sure. I’ve gotten zero saying, “You don’t have enough apps on your platform.”

So Cook makes two crucial points. First, for decades its identity and positioning have been about being better, not cheaper. Secondly, there is no evidence (even with Android’s superior share) that Apple has any problems with developer loyalty (at least in developed countries).

But the most important point is the one that he hinted at but didn’t finish: “I don’t think all market share is created equal.” Samsung’s smartphone profits are dropping while Apple’s rise. Every year, I have to remind my students that unprofitable growth destroys value for firms — if necessary, reciting the old adage “losing money on every unit, but making it up on volume.”

So while Sony is losing to commoditization, and Samsung is fighting it, Apple (thus far) is keeping at bay. For now, Samsung looks more like it's trailing Sony 10-15 years behind than it is catching up to Apple.

For Dell, the future ain't what it used to be

Thursday’s decision by Blackstone’s private equity partners to give up on buying Dell marks the end of an era.

The failed bid is an important story on many levels. I'll ignore for now the temptation for schaudenfreude after Michael Dell’s faulty prediction 15 years ago that Apple was worthless and should be liquidated. (Friday’s closing market cap: Apple $367 billion, Dell Inc. $23 billion).

Let’s also ignore that the end of the Blackstone bid appears to assure the success of Michael Dell’s $13.65/share offer to buy Dell Inc., funded by Silver Lake Partners. With this, shareholders must set aside very real concerns about Mr. Dell’s proposed buyout, particularly the conflict of interest from a CEO-founder who IPO'd his company and now wants to buy it back after the shares have fallen 2x since he returned as CEO in January 2007.

Instead, let me focus on two key insights Friday — from stories Friday by Bloomberg and the Wall Street Journal — on the real story on why the buyout collapsed.

The first reason was the collapse of the PC industry. As the Blackstone notice to Dell Inc. remarked (as quoted by the New York Times):

While we still believe that Dell is a leading global company with strong market positions, a number of significant adverse issues have surfaced since we submitted our letter proposal to you on March 22nd, including: (1) an unprecedented 14 percent market decline in PC volume in the first quarter of 2013, its steepest drop in history, and inconsistent with Management’s projections for modest industry growth; and (2) the rapidly eroding financial profile of Dell.

Or as IDC reported on April 10:

Worldwide PC shipments totaled 76.3 million units in the first quarter of 2013 (1Q13), down -13.9% compared to the same quarter in 2012 and worse than the forecast decline of -7.7%, according to the International Data Corporation (IDC) Worldwide Quarterly PC Tracker. The extent of the year-on-year contraction marked the worst quarter since IDC began tracking the PC market quarterly in 1994. The results also marked the fourth consecutive quarter of year-on-year shipment declines.

The second reason was the rapid collapse of the financial prospects of Dell Inc. To quote from the WSJ,

Another issue, some of the people said, was a seeming freefall in Dell's forecasted operating income. While some Blackstone executives initially had hoped the predictions were worst-case scenarios, in due diligence they concluded the predicted outcomes were spot on, and the numbers could come in even lower, the people said.
…
Dell, in the March 29 filling, predicted adjusted operating income of $3 billion for the fiscal year ending next January—a stark contrast to the $5.6 billion the company had predicted the previous July.

Dell hoped to diversify into other areas, but that has failed. As the Bloomberg story reported: “the enterprise-solution business, heralded by analysts as Dell’s future, was years away from competing meaningfully in that market…”

In other words, we’re at the tail end of the PC era. Although it’s coming more rapidly than expected, the outcome is as predictable as it was for bookstores, record stores or newspapers. Dell had hoped to diversity its way out of the problem, but so far those efforts have failed.

The implications seem as bleak for the rest of the PC industry. As part of a “Dogs of the Dow” value investing strategy, I own a few hundred shares of Intel, which has gone nowhere in the past two years. Microsoft has done only slightly better, due to hopes (IMHO unfounded) that it will someday benefit from the shift to smartphones and tablets. Even Apple has major exposure to personal computers, where it has been gaining share as its tablet share (but not unit sales) has fallen.

More significantly, in the late 20th century Dell was the winner of the commodity PC industry, but then was out-commoditized by Mark Hurd at HP. Right now the commodity business is going badly for both.

From 1960-2000, we saw the collapse of the mainframe, minicomputer and workstation industry. It wasn’t the low-cost firms that survived to the bitter end, but the high value-added ones. The others morphed into something else (NCR: ATM machines; Burroughs and Univac: IT services), exited or died.

Given that HP and Dell have negligible presence in the most rapidly growing computing segments — smartphones and tablets — what’s left 10 years from now will be two very different companies. HP’s done a better job of diversifying than Dell, but neither’s prospects are terribly attractive.

Death of Newsweek magazine: inevitable or self-inflicted?

Along with newspapers, we also have dead tree magazines going away — the latest being Newsweek announcing Thursday that its print edition is finite at the end of 2012. MarketWatch went out on a limb and said that Newsweek “won’t be the last venerable media organization to take this drastic action.”

The NYT notes that the 80-year-old magazine recently took an odd turn with its forced marriage with The Daily Beast, an online-only opinion site. This came after audio magnate Sidney Harman bought this once lucrative weekly magazine franchise for $1 from the Washington Post Company in 2010. Harman’s heirs indicated earlier this year that they were no longer throwing good money after bad.

From the 1960s through the 1990s, Newsweek was one of the country’s most influential national media outlets, the Avis to Luce’s Time magazine. (The #3 magazine, US News, ended its print subscription in December 2010.) Today, information is no longer scarce, and killing trees is an inefficient way to deliver such information.

It’s certainly true that a weekly magazine delivered two days late to supermarket checkstands is a difficult sale in this era of instant Google-fed gratification. However, some commentators wonder whether the death of Newsweek is as much a function of its final (print) editor, Tina Brown. As the AP reported:

They say it speaks to the magazine's trouble connecting with and keeping its readers.

That brings to mind some questionable covers, like the July 2011 what-if image depicting what Princess Diana would have looked like at age 50, or last month's "Muslim Rage" cover depicting angry protesters, which was roundly mocked on social networks like Twitter.

Newsweek is using a difficult print ad environment as an "excuse" for its decision to end print runs, said Samir Husni, director of the Magazine Innovation Center at the University of Mississippi School of Journalism. He lays the blame at the feet of Tina Brown, the editor who took control of Newsweek when it merged with the news website she ran, The Daily Beast, two years ago.

"Tina Brown took Newsweek in the wrong direction," Husni said. "Newsweek did not die, Newsweek committed suicide."

Cutting their way to greatness, Espoo Edition

The news from Espoo this morning was grim: Nokia is axing 10,000 (about 8%) of its workers over the next 18 months, in hopes of getting operating expenses (for its core Devices & Services division) down to €3 billion by the end of 2013 (vs. €5+ billion in 2010). The company will be closing R&D facilities in Germany and Canada and a factory in Salo, Finland.

In conjunction with a new earnings warning, Nokia’s market cap fell to €8.3 billion, shares shares fell to their lowest level in 16 years, less than 3% of its peak back in late 2000. The cumulative effect of the layoffs mean that in five Nokia employees will be gone by the end of 2013.

In conjunction with the announcement, three executive vice presidents are resigning at the end of the month “to pursue other opportunities outside of Nokia”. CEO Stephen Elop offered touching testimonials upon their departure:

"Jerri has made a positive impact on Nokia's advertising, marketing and brand efforts. Our marketing has made great strides under her leadership," said Stephen Elop. "I will particularly miss the fresh insight and new energy that Jerri injected into the Nokia brand."

"Mary's leadership has been instrumental in our efforts to connect the next billion people to the Internet through innovation in new devices and services," said Stephen Elop. "Under her direction, Nokia has brought new opportunities to consumers throughout growth markets and contributed strongly to Nokia's business. I will miss the value she has brought to Nokia."

"During his 16-year Nokia career, Niklas has successfully supported our growth and transformation through leadership roles in groups ranging from services to, most recently, sales, marketing, supply chain and IT," said Stephen Elop. "Niklas has been a valued partner to me during my tenure at Nokia and his many ongoing contributions will be missed."

If that were true, why were they all forced out? For that matter, why are these execs being forced out and not the CEO? So far, there’s no evidence that any part of Elop’s strategy is working.

Mercury News tech columnist Troy Wolverton was even more cynical about Nokia’s announcements, as he tweeted:

Troy Wolverton @troywolv
Nokia's press release about its restructuring is an amazing collection of Orwellian doublespeak, starting with its headline...

Troy Wolverton @troywolv
Here's the headline: "Nokia sharpens strategy and provides updates to its targets and outlook"

Troy Wolverton @troywolv
What that really means, in plain English: "We're firing 10,000 people and our bottom line is going to be much worse than we forecasted."

Troy Wolverton @troywolv
I love this line too: "...Nokia is making changes to its management team by tapping into the strong leadership bench at the company."

Troy Wolverton @troywolv
What that really means, of course: We're firing a bunch of executives...

Nokia was the world’s largest handset vendor from 1998 until this year, when it was passed by Samsung. Its market share has been in a freefall, and the profitability story has been even worse as it lost the profit sanctuary that the N-series phones once provided b.i. (before iPhone).

Part of the problem is that Nokia didn’t move quickly enough to respond to the iPhone. I was a consultant to Symbian (which made the N-series operating system) from Dec. 2006 to Dec. 2008, and while there was an appreciation of some of the iPhone features, I don’t think the company was really worried. For indirect evidence, it appeared that the Nokia execs were even more confident than their English software supplier — until Android came along. Today, Apple sells more smartphones than Nokia and earns most of the handset industry profits.

Right now, I don’t see how Nokia’s going to turn things around. On the one hand, as they phase out Symbian they’ve given up platform control for most of their smartphones — having cast their lot with Microsoft. On the other hand, Samsung is also dependent on others for its smartphone platform — i.e. Google — with only about 12% of its phones that carry the Bada operating system.

Theories for the differing outcomes abound. One is that Samsung bet on the right smartphone and Nokia didn’t. Certainly no one is enjoying great success with Windows mobile phones, while Android is the bulk of the smartphone market. However, I think the Nokia’s long indecisiveness was part of the problem: it shipped its first Windows in late 2011, 2 1/2 years after Samsung’s first Android phone.

Today, there‘s one differentiated platform — the iPhone — and a bunch of commodity smartphone suppliers competing on execution — via time to market, small feature enhancements, and of course price. Nokia made its money when it had customer lock-in as the only game in town, and its DNA is not well-aligned for today’s competitive price-sensitive markets.

But in hearing about the latest round of cuts reminded me of Silicon Valley companies also trying to cut their way to greatness, notably HP and Yahoo. Cuts will not make a mediocre company great — they will only cause it to lose less money. Success will come from growing the top line, and thus far Nokia under Elop (and his immediate predecessors) has been heading in the wrong direction.

Nokia resembles HP in that both were once world-renown innovative companies, and both have stumbled as the market matured and price premiums disappeared. Apple was in this place 15 years ago, but were turned around by brilliant market-driving innovation. However, the Apple Steve Jobs turned around was smaller, more nimble — and more scared — than Nokia is today. If there’s a reason that Nokia’s slide will eventually end, so far I haven’t seen it.

Creative destruction creates carcasses

Veteran tech journalist Therese Poletti this morning looks at the tough choices facing the new(ish) CEOs of three established tech companies. The double-deck headline in Marketwatch says it all:

April 3, 2012, 12:01 a.m. EDT
Can new CEOs fix H-P, RIM and Yahoo?
Commentary: H-P has best hopes, future grimmer for RIM and Yahoo

She begins the story by quoting Clay Christensen from his talk last week at Xerox PARC — a nice touch and obviously a point of view I wholeheartedly endorse.

But then she gets to the money quote:

Once companies have lost their edge, can they ever climb back? In the case of H-P, RIM and Yahoo, the outlook appears to be the best for H-P, worse for RIM, and Yahoo could eventually just be sold, or cut up into bits.

“They have moved to the carcass phase of the business,” said Stephen Diamond, an associate professor of law at Santa Clara University. “That is a very bad sign. That is very interesting for lawyers and vulture funds. But to expect those companies to turn around technologically is all but impossible. H-P may have narrowly averted that,” he said, adding that he believes the tech giant needs to eventually find a more visionary CEO with more tech or engineering creds, or it too will lose its way.

Carcasses? Ouch!

The pessimism on Yahoo seems conventional wisdom. Yahoo was listed among “four dying companies” over three years ago, and the other three have essentially been carved up: Palm bought and essentially killed by HP, Sun swallowed up by Oracle for its patent portfolio, and AMD making a bold (i.e. risky) shift to a fabless/outsourcing model.

Meanwhile, the travails of RIM and HP have been well chronicled. All three companies are at a point — as Apple was in the mid-1990s — where their troubles are so great that they have trouble attracting a top tier CEO. In offering the most optimistic view of HP, Poletti sees CEO Meg Whitman as a savvy corporate politician and transitional figure, who sets the ship aright but then turns to the reins over to a technologist (possibly inside) leader.

This plays to a conjecture I’ve been trying to nail down for my book on engineering entrepreneurship: great technology companies have to be led by great technologists. (Steve Jobs might be an exception to this rule, but he was an exception to nearly every rule).

Still, these are companies that have hit a difficult time, having lost (or in the process of losing) their once certain moneymaking franchise to commoditization and other market turmoil created by creative destruction. As Prof. Christensen notes, this is the inevitable way of the technology-enabled world.

Big pharma hasn't solved commoditization

Cross posted from Bio Business Blog.

Many reporters, analysts and other observers over the past decade have remarked on how the traditional big pharma business model has been running out of steam. Proposed solutions have included buying biotech companies (as Roche did) and forming generic divisions (as has Sanofi). Still, from outside, the (in)actions of big pharma resemble the controlled flight into terrain of other IP companies.

Last week, two consultants from Booz & Company published their own analysis of the problems in the Booz house journal, strategy+business.

Alex Kandybin and Vessela Genova deduced the strategic choices of 10 major pharma companies (Abbott, AstraZeneca, Bayer, GlaxoSmithKline, Johnson & Johnson, Merck, Novartis, Pfizer, Roche, Sanofi) through their acquisitions and divestitures from 2004-2010. Nine of the 10 have bet on biologics, five on OTC, four on generics and one (Sanofi) on animal health.

They draw an analogy to the choices of the computer industry:

Most industries go through periods of both deterministic and stochastic development. For instance, the computer industry in the 1960s and ’70s had all the characteristics of a deterministic process. IBM, Burroughs, Cray, and others pursued similar strategies, selling giant data processing machines known as main- frames. The personal computer changed the dynamics of the industry, triggering a turbulent stochastic period. It became impossible to predict where the computer industry was going, and in the early 1980s the incumbent players’ strategies diverged significantly.

This is, alas, an inaccurate revisionist view of the industry: in the 1980s, it was quite clear that the PC was democratizing computers and that standardized microprocessors enabled market entry and reduced margins.

More importantly, the computer industry of the 1970s has significant a priori heterogeneity: it was not for nothing that people referred to IBM and the Seven Dwarfs (or IBM and the BUNCH). Cray was in a very narrow and dangerous niche diametrically opposed to commoditization trends and desperately dependent on Cold War spending.

One place where the authors clearly have it right is that big pharma is fleeing from the highest margins in the life sciences (and among the highest margins anywhere) towards average or sub-average margins. The operating margins of pharmaceuticals is 29%, vs. 12% for generics, 8% for services and 2% for drug wholesaling.

This is utterly consistent with the 15-year-old observations of Clay Christensen: lower cost solutions eventually supplant higher cost solutions, destroying margins. Or, as my former colleagues Jason Dedrick and Ken Kraemer showed in their 1998 book, IBM’s shift from hardware to services dramatically grew revenues but cut margins.

What to do? The authors offer fairly generic (i.e. undifferentiated) advice: firms should embrace change, consider multiple scenarios, and assess the firm’s unique capabilities.

In the end, the old model of one-size-fits-all drug is breaking down. What will replace it? One prediction is personalized, genomic-based medicine. But even if that’s true, many uncertainties remain, including how quickly that future will get here and which part of the value chain will be the most unique and thus valuable.

Insincerity as a business model

I'm spending over a day of my life this week in completely full steel tubes, shuttling back and forth from the West Coast to Old Europe. For that, I am being rewarded with "miles" that may someday allow me to spend more time in cramped steel tubes.

This time, the most convenient routing put me on United-Continental. While once the old Continental provided nice amenities — like seat power in coach — the new merged airline is racing to the bottom with United’s trademarked approach of treating coach passengers like the worst people in the bottom floor of steerage on the Titianic. All the while, they want us to believe the merger is good for service quality.

To that end, the nominal safety video began with a propaganda piece by new United CEO Jeff Smisek trying to convince us that what we were seeing was better service. This is the same message Smisek has been preaching for a year, since Continental disappeared as an independent company.

But when he concluded “Thanks for flying us and have a great flight,” it didn’t match the reality around me. In United Steerage™ there is no leg room, and on a 100% full 757 there is no shoulder room either. Being domestic coach, there was also no food unless you wanted to pony up airport-style prices. Trapped in my seat, I got a lot of work done, but I wouldn’t confuse it with a “great flight.” Thanks to deregulation and commoditization, we have reasonable fares but great service is a distant memory.

Similarly, the stewardess-presenter on the safety part of the video concluded “We ask you to relax, sit back and enjoy your time with us.” Surrounded by humanity and unable to move, in a seat that barely reclines, and without a clear view of the tiny movie screen, I wouldn’t say I ever relaxed, sat back or enjoyed much of anything.

It gets better. After one flight, I got an email asking for my opinion in an online satisfaction survey. After I gave them an earful, the computer said:

Thank you for taking the time to complete this questionnaire! The information you provided will help us ensure we are meeting your needs.

However, I know full well that they’re not going to change their business model or pricing policy based on mere customer complaints — losing market share, maybe, but right now they assume they can make money by being bigger rather than better. This is, after all, the airline that invented a category worse than coach — Economy Minus® — lowering the standard seat pitch to 31", even less than Southwest. This is also the company that pioneered charging for bags, meals and movies.

So as someone with several decades as a consumer (and graduate courses in marketing), I wonder why people say this? Are they just naturally insincere? Have they ever heard of cognitive dissonance? Do they think people won’t notice? Or do they hope people assume that the service is just as lousy on every other competing airline?

Orwell and Goebbels said you could lie to people repeatedly if they had no frame of reality to compare it to. Does any private business (as opposed to the Federal government) think they have enough control over the media to be able to get away with it?

HP's acts of desperation

Since last week’s huge news about HP I’ve been hoping to write something, but I was traveling and didn’t time to collect my thoughts. Even after five days, the news still doesn’t make sense, other than as the death throes (or at least mortally wounded throes) of a once-great giant.

Yes, HP has serious problems. It’s been unable to find a decent CEO since its founders (NB: Apple, Microsoft). Simultaneously chasing both Dell and IBM, it caught and passed Dell for a prize it no longer wants, while it seems unlikely to ever catch IBM (at least in my lifetime).

The HP board and CEO Léo Apotheker seem incapable of dealing with the current challenges. It has come to having HP’s chairman bad-mouthing Apotheker’s predecessor for “under-investment” in the core business.

But this is only the latest desperate effort in more than a decade of throwing one Hail Mary pass after another. Its $1.2b purchase of Palm and webOS was (as predicted) a major mistake. It allowed the (previously dying) Palm cellphone business to die, and meanwhile the efforts to establish the TouchPad as a viable iPad rival has failed miserably (much like RIM) with Best Buy selling less than 10% of those ordered and HP writing off $1 billion in losses on the webOS hardware business — most of that on the TouchPad.

Yes, a couple of things make sense from the announcements. Yes it’s time to cut the losses on the webOS acquisition (Perhaps claiming it has a future as a consumer embedded OS postpones the inevitable write-down, but competing against a no-royalty embedded Linux will be difficult at best.)

And at some level, the divorce of the low margin PC business from the potentially high margin software/services business has a business logic. Mark Hurd was the right man to run the commodity business while Apotheker prefers higher margin services, and neither was suited to run both together in a single company.

The problem is that the current HP is a conglomerate of the leading commodity PC maker, the leading (increasingly commoditized) printer maker, and a hodgepodge of largely second-tier software and services businesses.

Under Hurd, the company had embraced commoditization — executing on Carly’s Compaq acquisition and doing an exemplary job of competing in commodity markets. The only cost was the heart and soul of Bill and Dave’s company, ripping it out as the company shed workers, perks and the exemplary culture that once inspired Steve Jobs and Steve Wozniak.

Then the HP board panicked over Hurd’s poor judgement and forced him out, replacing the successful commodity numbers weenie with just the opposite: a software guy that was presiding over the dying SAP franchise. Apotheker had not solved SAP’s problems — coasting on the inertia of its once-invincible lock-in rents in the BPR segment — so he was rewarded with the reins of Silicon Valley’s oldest and most storied company.

A completely different CEO meant a completely different strategy, which in turn requires a different portfolio of businesses. (It also requires different competencies up and down the line, which the latest moves pointedly do not address.)

Even if exiting PCs now makes sense, as others have noted HP has completely bungled the planned PC spinout. IBM’s decision to sell its division came as a bolt from the blue with the buyer already announced. Apparently HP shopped the PC business and didn’t get its desired price, so now the uncertainty around the PC division (the born-again Compaq) will cause it to hemorrhage customers and market value until it’s finally dumped.

In the end, I have to lay the current problems on the board, which brought us the infamous spying scandal, melodrama over the last 3 CEO appointments and of course forcing out its best directors, Tom Perkins (of Kleiner Perkins fame) and George Keyworth. As Perkins noted in a 2007 video and his memoir, the board groupthink forced out any dissenting view — which (to further mangle metaphors) is a recipe for marching lockstep over a cliff.

Who’s on the board? Two insiders, three private equity investors, a failed startup technologist turned investor (Mark Andreessen), a former consumer products exec (Meg Whitman), execs of two failing telecom companies, the CEO of a successful software lock-in business, CEO of a major consulting company, chairman of a specialty chemicals business, and Larry Elison’s longtime sidekick (turned nemesis and Kleiner Perkins managing partner).

Oddly, while the board has exemplary gender diversity it lacks the obligatory university professor or president. I suspect Intel benefitted greatly from the advice of longtime director David Yoffie — even if I didn’t always agree with his analysis. (If HP goes looking for an academic, Tim Bresnahan of Stanford has understood the economics of platform businesses longer than anyone.)

Apparently I’m not the only one fed up with the HP board. After the 20% drop in HP stock Friday, fellow Seeking Alpha contributor Vitaliy Katsenelson wrote:

Anger and frustration are the two emotions pulsing through my veins as I write this. HP (HPQ), once the symbol of innovation, is being dismantled by its high-pedigreed board and the CEO of the hour. … [In] the early 2000s, when Carly Fiorina, then CEO of HP, engineered the HP merger with Compaq. … [N]ine years and two CEOs later HP has announced that the PC business, the one it so desperately wanted just a decade ago, is too hard a business and that it will look for ways to get rid of it. Almost in the same breath HP announced that it will kill WebOS devices, a business it acquired in April 2010 for $1 billion; and management, possibly missing the irony in those two announcements, went ahead and announced another acquisition, which this time will for sure transform the company.
…
I don’t need to have a great imagination to envision another conference call in August 2015, where a new CEO decides that the software business is too difficult, and HP needs to come back to its roots (maybe going back to making calculators) and will spin off the software business into a new company, take an enormous charge, and then maybe announce an acquisition that the same highly pedigreed board will rubber-stamp.
…
HP’s stock sold off not because the company disappointed Wall Street but because Wall Street grew tired of the overpriced “must-have” acquisitions. Wall Street has smartened up and assumed that this acquisition, as with many other “transformative” acquisitions, will do nothing of the sort.

I’d like to hope that HP will turn around some day, but I can’t see how to get there from here. It would require an entirely new board, one with more winners than losers and more big company operating experience. HP and its board are too big to be threatened with a hostile takeover, and so will muddle along — acquiring baubles with the shareholders’ checkbook — without a coherent long-term strategy or market niche.

Network effects and self-perpetuating incumbents

As part of my travels to and from the latest user innovation conference, I’ve been traveling through a lot of airports.

Airport hubs are an example of both network effects and more general IO economics (i.e. Michael Porter) barriers to entry and supplier power. With enough market power — such as by reducing rivalry through mergers — large airlines can offer mediocre service at a high price and people will be stuck paying it. (Or, they won’t fly.)

This is particularly true since airlines have accepted commoditization of their service, with few offering differentiation. (Frequent flyer plans were once intended to offer differentiation, but once everyone copied them, all they do is create switching costs which discourage price shopping by business customers.)

Flying through European capitals this week, I realized how my view of airline competition was distorted by the US experience, where a few Midwest (or non-coastal) cities got nabbed by airlines to build fortress hubs: Chicago (United, American), Dallas (American, Delta), Houston (Continental), Atlanta (Delta), Pittsburgh (US Air), Minneapolis (Northwest), St. Louis (TWA), Salt Lake City (Western) — or secondary hubs like Denver (United), Kansas City (TWA), Cincinnati (Delta), Detroit (Northwest) and so on. A few international airlines had the bulk of their international departures from key “gateway” cities like New York, Miami, San Francisco and Los Angeles, but only later did these become international hubs.

In Europe, the pattern is very different. Most countries had one airline which offered non-stop flights from their capital (or largest city) to key international destinations. And of course for minor obscure languages, the national airline meant customer service in a language you understood.

Only later did they convert their capital to a through hub to attract through passengers. Judging from my efforts to book connecting tickets to small EU cities online, the most successful seem to be British AIrways (London), KLM (Amsterdam) and Lufthansa (Frankfurt).

Airline hub theory states that to make a hub work, you need both connecting passengers and terminating passengers (whether local residents or visitors). So big cities like NY, LA, London etc. have a lot of built-in demand to support the hub.

A few things surprised me about this airline competition during trip. One is the reminder that 40 years ago, every country (even Belgium) wanted its own airline no matter how sub-critical mass it was. Exhibit A: Sabena Airlines.

Meanwhile the Scandinavians (except Icelanders) swallowed national pride and combined the local demand of three countries. Even so, sitting in the SAS hub in Copenhagen today, it seems surprisingly weak compared to my first visit 15 years ago — in terms of size of planes and number of destinations.

I guess the problem is that Copenhagen is the connecting hub but Stockholm has twice the local traffic, so neither is particularly viable. Also, the rise of the Star Alliance and code-sharing means that it’s easier for SAS to code-share with longhaul partners than to offer its own tiny fleet of long-distance jets. (It was interesting to note that nonstop traffic between Japan and Germany is carried by both Lufthansa and Star Alliance partner ANA, with every flight by one code-shared on the other.)

The final observation is the reminder that the natural reaction to rent-seeking and extortionist monopolies (the aspirational goal of most airlines) is to encourage new entrants to do a better job. In the US, we hear about Ryanair (more penny-pinching than Southwest) and EasyJet but not the dozens of others that have sprouted up.

For this trip, to save $500 I bought a separate ticket from Copenhagen to the Vienna conference on AirBerlin. However, I ended up on Niki, the smaller Vienna-based Austrian discount airline that it acquired in 2010. Both seem to be German-speaking versions of Southwest, catering to German-speaking travelers, but (unlike Ryanair or EasyJet) offering slightly more amenities than Southwest (i.e. a free cold meal). I guess AirBerlin (which has longhaul flights to the US, the Caribbean, Africa and Southeast Asia) is a German version of Virgin Atlantic, but without Sir Richard and his out-of-this-world ego.

Niki is strictly a European short-haul carrier. Even though it is tiny (21 planes), it was clear at Vienna airport it was cutting into the business of Austrian Airlines (the former national carrier acquired in 2009 by Lufthansa). In Copenhagen we had Sterling and Norwegian, and of course European authorities showing (a limited) interest in competition has transformed the airline industry to make these carriers cheaper and quicker (if not quite as convenient) alternatives to the monopoly national train systems.

But then, that’s not that different than the US, either. American’s attempts to control Dallas passengers helped fuel the success of Southwest. Delta’s control of Atlanta begat ValuJet (rebranded to AirTran after that terrible crash) which is now a division of Southwest.

Interestingly, it seems that big destination cities are impossible to dominate. No single airline has dominated NYC or LA the way the middle-American hubs have been dominated. (Perhaps PanAm did so once upon a time, but that was well before my time). And if you look at London, while BA is by far the largest carrier, it has lots of competition.

In the end, it comes back to a first-year strategy principle: businesses hate competition and choice (except with suppliers) and customers love it. The entire field of IO economics is about how incumbent firms can develop monopoly (or oligopoly or monopsony) strategies and how new entrants and customers conspire to destroy them.

Smartphone vendors learn: commoditization is hell

As previously noted, the major goal of Android was to commoditize smartphones, to make them widely available from a wide range of sources. Consumers like open standards because they bring, entry, competition and lower prices — a point I made in a 2007 book chapter.

As any first year strategy student can tell you, low entry barriers that bring high rivalry and high buyer destroy industry profit margins. Assuming the major cellphone makers each employed one MBA graduate, this should have been utterly predictable.

But apparently this is news, at least according to a report by John Paczkowski in All Things D that quotes analyst Trip Chowdhry:

He says that Sony [i.e. Sony Ericsson], Motorola and Samsung are growing disillusioned with Google’s Android OS. They feel there’s too much fragmentation and too little differentiation among Android devices and that companies producing low-end handsets are collapsing the premium market they’d most like to play in.

“They’re starting to realize that their Android devices [are no different] in the eyes of the customer [than a] $20 Android Phone from Huawei,” Chowdhry says. “They’re worried that Android may dilute their global brand as customers put them in the same bucket with Acer, Asus, ZTE, Huawei, and MediaTek.”

Uh, yeah, we’ve seen this story before: it was called the Wintel PC (or for oldtimers, the IBM PC compatible.) Cellphones are worse, since the carriers control distribution and have an interest in selling the cheapest phone they can.

To prevent this lack of control and divergence of interests, these three branded vendors were co-founders and shareholders of Symbian. In the end, only Sony Ericsson took Symbian seriously.

Today, Chowdhry suggests that the big three should license webOS from HP. Two aspects of the report makes sense. One is that webOS is a modern, high quality smartphone OS. The other is that HP has negligible share and isn’t competing with them.

Still, the major handset makers are no more interested in sharing a standard with webOS than they were with Symbian. And the high royalties ($50-75/device) that Chowdhry proposes are not going to fly with companies that pride themselves on hardware designs.

WebOS and its (former) owner Palm are really a US brand. I think HP’s best shot would be to approach either Motorola (which is still US-centric) or Sony Ericsson (which is even more seriously in trouble) to see if they’re interested. HP could continue to use webOS for tablets and other devices.

Samsung is a lost cause. They put small bets on every open platform (Symbian, Windows Mobile, Android) while still hoping their proprietary bada platform will catch on outside Korea.

After two years of negligible sales, whatever window webOS has as a smartphone platform has just about closed. It takes more than a better mousetrap to get traction in a platform market: it also requires developers, hardware vendors, distribution and end users.

Commoditization is hell

In an AP dispatch† from the distant reaches of San Francisco, the San Jose Mercury News today reported that the life of a videogame developer ain’t what it used to be:

Nintendo President Satoru Iwata said in the conference's keynote speech Wednesday morning that "game development is drowning" because of the rise of cheaply made and priced mobile and social games. He expressed concern that those platforms have "no motivation to maintain the value of gaming" and that they lower gamemakers' ability to make a living.

In other words, 99¢ iPhone games have killed the market for $60 console games.

Hmmmm...let’s see. Consumers would rather have a cheap portable way to pass the time rather than an expensive immersive experience that requires they sit in front of a TV all day.

Actually, the concerns of developers are exaggerated. The industry is cyclical, chronically depending on the latest hit console — at a time when the major console developers are stretching out platform life cycles, trying to milk their cash cows for all they’re worth.

The problem seems to be that the industry believed its own hype that it would soon surpass the movie industry in revenues and societal impacts.

There’s no reason to suspect that videogames would be immune from the commoditization pressures facing any other industry.

As with any technology-based industry, the growth of performance eventually slows downs — or efforts to add features no longer increase the value perceived by customers. As Clay Christensen noted, the threat in these cases is that a cheaper technology soon becomes good enough.

Time to face reality: commoditization is not going away. The 99¢ games will become more compelling as the mobile devices become more powerful, siphoning off business from the high end formerly mainstream product.


† Apparently the Merc had to close their San Francisco bureau due to budget cuts, or perhaps they decided to stop covering videogames since ace reporter (and author) Dean Takahashi jumped ship.

Dumb providers of dumb pipes

The Financial Times reports that European mobile phone operators plan to hold a meeting next week in hopes of charging content providers for delivering data traffic. As the paper so dryly put it:
told the Financial Times that there could be “no free lunch” for the content providers.

Franco Bernabè, chairman of the GSMA, the mobile operators’ representative body, told the Financial Times that there could be “no free lunch” for the content providers.
…
Mr Bernabè, who is also chief executive of Telecom Italia, Italy’s leading telecoms company, highlighted how fixed-line and mobile operators were spending billions of euros upgrading their networks to cope with the rapid growth in internet video traffic.

He complained that content providers were “heavily using our networks but just don’t contribute to the development of our networks”.

I understand that operators resent the failure of their walled gardens and are in denial about being consigned as commodity providers of dumb pipes.

If it’s too expensive to provide network access, why don’t they charge more? OTOH, if they start reaming people for data access, who in the heck do they think is going to pay to use their networks?

Perhaps in some of the countries a cozy duopoly holding two-thirds of the market hopes to forestall competition by striking a common position against content providers and consumers.

However, in most countries there is usually one desperate challenger seeking market share who will do what they can do to gain a foothold. There are also operators hoping their LTE networks will provide new traffic and revenues, as well as Wi-Fi and other substitutes available.

Finally, there’s this little matter of the mobile Internet — as the iPhone proved, it’s the whole reason people buy smartphones in the first place. So if people can’t get access to the free Internet, why would people want a smartphone? Goodbye free Internet, say goodbye to ARPU.

In short, this plan of the operators is a dumb idea. I wonder how quickly it will take for the operators, content providers, regulators, consumer advocates or the business press to figure this out.

Commoditization is hell

Tonight I parked my car, walked by the empty shell where our neighborhood Blockbuster used to be, and went into our local Safeway. My first stop was the Blockbuster kiosk inside Safeway, to rent a recent Harry Potter movie prized by our eldest.

Even before the store closed, we only rented about one video/year there. Instead, we have been renting from the two local kiosks — DVDPlay in Safeway and RedBox in Lucky. Unlike two years ago, tonight I could check the availability of movies at each kiosk before I left the house.

I suppose this is a small victory for Blockbuster, since this kiosk is now a “Blockbuster Express” kiosk since NCR bought DVDPlay 13 months ago and entered a joint venture with Blockbuster.

But I used to pay the local Blockbuster franchise $3-5 per rental, whereas the kiosk grosses $1 per rental. Hollywood is still garnering the largest share of the COGS, while meanwhile Blockbuster gets a small part of the money left after Hollywood, NCR and the grocery store get paid. (The exact financial terms between NCR-Blockbuster don’t appear in either company’s 10-K).

So realtime rental of physical DVDs remains brutally commoditized while some predict it will only get worse as the two major players duke it out.

Meanwhile, DVD downloads appear to be dominated by Netflix (just as Apple has two-thirds of the audio downloads). Much as the studios would like to commoditize all distribution, they have thus far failed to do so for digital downloads — the only channel that is likely to matter a decade from now.

Even tech industries grow up someday

When I started the professor gig back in 1998, I had a smug sense of superiority: I’m a tech strategy guy, and I didn’t worry about the dinosaurs and dying industries and boring stable mature industries.

Since that time, we’ve had the dot-com crash, the NASDAQ crash, a decade of sideways tech stocks (some still below all-time peaks) and in general a mature, commoditized IT industry, including once-great companies like HP and onetime high growth companies like Oracle.

This is not just IT, but also the onetime epitome of high R&D/sales ratio and science-based differentiation, i.e. big pharma. Reflecting declining returns to R&D, big pharma has underperformed the S&P 500 for 15 years — even before the dot-com crash — and has responded by budget cuts, layoffs and offshoring.

In other words, all industries grow up someday. Light bulbs and transistors and telegraph wire were once cutting-edge too. Masked (slightly) by mergers and acquisitions, companies like Oracle and SAP lost the ability for organic growth almost a decade ago. Today the tech products — like PCs or phones or tablets (or proprietary pharmaceuticals or PV panels) have to worry about cost-based competition and the perennial threat of substitutes.

Given that, I’m now convinced that every would-be high-tech MBA needs at least a half-semester (or one-quarter) course on strategic marketing in mature consumer industries. We have a lot to learn from selling autos and soap and sugar water — despite what Steve Jobs said about selling sugar water almost 30 years ago.

Yes, we’d like to think (thanks to Moore’s Law) we’re not peddling tail fins but instead an ongoing stream of incremental improvements. Still, well-run companies in mature industries have a lot to teach us about product proliferation, cost engineering, consolidation, and buying/selling companies, not to mention maintaining and leverage brand equity in the face of commoditization.

In fact, I just got through reading final exams about soft drinks in the late 20th century. From 1975-1995, the two major cola companies squeezed out the smaller companies as they grew their share from 45% to 73%. (Does anyone remember drinking 7-Up? Of being able to buy it in a restaurant or on a plane? I do.) This growth occurred as they also grew the pie, with per capita soft drink consumption almost doubling during this same period.

Sure, New Coke is right up there with the PC Jr. (what?) or Lisa, Apple /// and Newton (huh?) as great marketing flops. Still, while all the growth this century will come from developing markets, both KO and PEP stretched their run out for another decade through a variety of product, marketing, supply chain and corporate-level strategies. The US auto makers haven’t done so well — Ford better than most — but the Europeans and Japanese have coped well with a maturing market.

Of course, high-tech marketing people need to learn how to do real consumer marketing. Intel and Qualcomm have grown their own, while Apple’s top marketing execs came from Macromedia (a software company) and Target. (The difference between Jobs I and Jobs II was the intervening experience building a consumer brand at Pixar.)

Ideally, the course on strategic marketing would be combined with a course on consumer marketing. However, the reality is that at most business schools, these are two separate skill sets not found in the same person.

Once upon a time business strategists studied Sun Tzu or Civil War battles. In the 21st century, they should study the cola wars, diversification efforts by the Japanese auto makers, franchising by Ray Kroc, the re-invention of water and coffee, and the branding of generic acetaminophen and ibuprofen.

Bad signs at the mall

AP says that shopping is better than this year than last. (Certainly it’s better than the England, where unfamiliar snowstorms are preventing stores from restocking.)

We ran out to the major Santa Clara mall this afternoon to buy a couple of items, and what I saw was signs that retailers were desperately discounting because traffic was lower than expected. Bath and Body Works had a number of 50% discounts and pretty much everything seemed to be 25-33% off. Abercrombie sold my tween a sweatshirt for 10% less than what we were charged on the morning of Black Friday — usually the day of deepest discounts.

Perhaps this was just the stores we went to — one for silly luxuries, one for stylish teen clothing. Other stores selling more basic goods could be doing great. Or it could be the Bay Area, or California more generally. After all, our statewide unemployment rate is 12.4%, or one-fourth higher than the 9.8% national figure.

In any event, this data is dissonant with the all-smiles-and-cheer view being presented by retailers.

A final possibility is that retailers underestimated how quickly demand would shift to online stores — which, as the WSJ notes, can now be consulted by smartphone-wielding shoppers as they stroll down the aisles. Given Silicon Valley has always had the highest penetration of e-commerce awareness and now has a relatively high smartphone penetration, this could explain the local desperation. After all, distribution is just another service that’s been commoditized by the Internet.

If I’m right, luxuries/frills/non-necessities will be heavily discounted on Dec. 26 — a great bonanza for those who have birthdays in January (or are willing to exchange gifts on Twelfth Night.)

Flash! Android is bringing commoditization!

the major goal of Android was and has always been commoditization: before Android smartphones were hard and now they’re easy. This is a point I’ve been making for a while, including August 2009, January 2010, March and earlier this month.

Now Forbes, its CIO network and the NPD consultants at PRTM have figured this out. To quote their article:

In 2007, Android looked like an experiment as well as a great and cheap way to challenge the extraordinary success of Apple and its iOS-iPhone-iTunes combination. But the success of the venture has unleashed a tiger, and now the handset companies are starting to look like its lunch.

More importantly, the PRTM consultants have put numbers to the trend:

• From Android 1.6 to 2.1, cycle time for new handsets dropped from 8 months to 4.5 months
• Most vendors bring new handsets to market within 16-20 weeks of a new Android release, eliminating any temporary OS exclusive.

To quote the report by David van Oss and Huw Andrews of PRTM, gross handset margins will shrink to the 8-10% common for commodity PC makers.

They encourage handset makers to find other sources of differentiation or perhaps look for a second handset OS. Perhaps they can use their custom Android UIs to create brand loyalty — I find this highly doubtful, but they may create gratuitous switching costs.

Van Oss and Andrews predict Google will charge a royalty for Android. Yes, the company’s got conflicting goals — promoting its mobile platform vs. promoting mobile search use. But I don’t see a scenario in the next 3 years that has Google trying to extract royalties from the Android platform. (Fine print: I won’t rule out it offering new “must have” royalty-bearing technology like voice recognition).

A lot could happen in three years. By then, Nokia could be making Android handsets, or the Chinese could be shipping the majority of the world’s smartphones. Or smartphones could be on their way out, replaced by tablets. So anything beyond then is pure speculation.

HP-Compaq Redux

Many of the most senior professors I’ve ever met — including some prize-winning engineering professors I interviewed in my research — say that to really understand something that you need to teach it.

Tonight in the capstone strategy class, our undergraduates revisited the 2002 HP-Compaq merger. We had a very healthy discussion, which I concluded by summarizing from my “Carly is right, I was wrong” posting earlier this year, particularly this passage:

• Opponents’s Claim: The merger would increase HP’s exposure to the commodity PC industry. Reality: True.
• Supporters’s Claim: The merger would give HP’s commodity business cost advantages through superior scale. Reality: True. Under Hurd, HP is a better commodity PC maker than even Dell.
• Supporters’s Claim: The merger would help HP increase service revenues. Reality: False. What was left of DEC wasn’t worth much, and so in 2008 HP spent $14 billion to buy EDS.
• Opponents’s Claim: Adding Compaq would dilute HP’s printer cash cow. Reality: True, but it didn’t matter.

However, from the student presentations I gained a few new insights:

• Many “experts” (including me) say that prior IT mergers failed and thus HP-Compaq would fail (cf. WSJ, CNET, USA Today, AP, Red Herring.) However most of the acquired companies were clear losers (Apollo, Sperry, NCR) or firms whose category was dying (Cray, DEC). Compaq was the global market share leader from 1994-1999, and still had almost twice the share of HP.
• HP didn’t beat Dell in PCs, Compaq did (using HP’s money, brand and distribution). HP was never any good at making PCs.
• As my student David Sheyman pointed out, at the time of the merger Compaq’s ProLiant servers were the market leader, preferred by IT buyers.

Yes, the PC business is a brutal low margin commodity business, but if nothing else HP deprived Dell of a profit sanctuary for attacking HP’s other businesses.

Consistent with one of major themes of this blog, commoditization is the reality of most segments for Silicon Valley IT companies. Commodity firms are less fun to work to work for, so students have to recognize the industries and firms that have become commoditized if they hope to avoid them.