Microsoft finds products trump business models

With its smash hit Kinect, Microsoft found itself with a conundrum: it was such a great sensing device that researchers and hobbyists wanted to buy it even without buying an Xbox 360.

Normally a smash hit is not a problem. But gIven the Kinect had the same razor & razor blade model as the Xbox, people buying it without buying Xbox games meant that the MS was not making the margins they hoped for.

For a while, Microsoft was fighting the hackers. I argued they shouldn’t fight, they should switch:

Microsoft is missing a significant market opportunity by not being open to third-party enhancement of the Kinect hardware. Although the volume will not be as big as for a hit game — as predicted by Karim [Lakhani] and his research — third-parties will identify markets and solutions that Microsoft never anticipated.

Sure enough, Microsoft has seen the light. On Monday, Microsoft announced it will release a noncommercial SDK for the Kinect in the spring:

While Microsoft plans to release a commercial version at a later date, this SDK will be a starter kit to make it simpler for the academic research and enthusiast communities to create rich natural user interfaces using Kinect technology. The SDK will give users access to deep Kinect system information such as audio, system application-programming interfaces, and direct control of the Kinect sensor.

The timing is right for Microsoft to continue to deepen its ties to industry. With Nokia pulling back from university research alliances — and Apple, Nintendo and Sony abdicating the fight — the Kinect win is a rare example of success at a time of decline for its core businesses and its chronic failure to win share for cellphones.

Wired observes:

Microsoft was particularly impressed by the University of Washington’s research into telerobotic surgery. Researchers at the university hooked up a Kinect to a PHANTOM Omni Haptic, a stylus-based device that gives resistance feedback to the user, to build 3D models that the user can actually feel.

So hand it to Microsoft to (as I suggest) work on building a platform around the successful Kinect technology, rather than protect its otherwise conventional razor (console) and razor blade (game) business model.

Google vs. Apple distribution price war

The first year of the tablet wars went entirely to Apple. Apple has the market share, installed base, the mindshare and the superior product. Most projections have Apple crushing the competition again this year, albeit by a lesser margin.

However, Apple needs to take seriously Google’s latest salvo in the tablet content distribution fight. If Apple hopes to keep the iPad the dominant tablet — in a way the iPhone and Macintosh never were and never could be — it needs to take this attack seriously.

Apple won many fans among software developers for its convenient app store in exchange for a 30% commission. But its proposal to extend commission to newspaper, magazine and all other subscriptions has been highly unpopular, and some have questioned whether this is really tenable in the long haul.

Then on Wednesday, Google said it would only take a 10% cut for its One Pass content store, a direct attack on Apple’s pricing model. (Isn’t competition great?) Although online distribution is a low value-added commodity — with oliogopolistic competition — I think Google can hold a 10% margin, because both Apple nor Amazon tend to prefer margins better than that.

If most of the online tablet media goes through such services, then Apple can make plenty of money on a 10% margin. The problem is protecting its margin for other App Store products. Already, publishers and developers have been trying to bypass paying Apple — using Apple to distribute free apps and trying to charge outside the app. Apple closing the loophole is fair — it deserves some compensation for its distribution — but its plan to keep 30% is not.

So will apps be 30% and content be 10%? Will everything be something in between? Will Apple be in denial about the price war until its share drops below 50%?

Apple already seems to have lost the book distribution fight. iBooks was stillborn, and I can’t see how it will ever catch Barnes & Noble, let alone Amazon or Google. Are magazines and newspapers the same distribution channel as books? I don’t think anyone can say for sure.

Apple was reasonably aggressive in responding to Amazon’s efforts to abolish DRM on music downloads, so I expect we’ll see their answer on or before the rollout of the iPhone 5 this summer. Will they protect their margins on the assumption they can hold the market another year, or will they respond aggressively to protect every bit of market share? That I can’t predict.

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.

Marks to market: buy low, sell high

I normally don’t write about stock prices, because my interest is successful company strategies, on the assumption that prices will eventually work out.

However, I would encourage all investors to read Jason Zweig’s Intelligent Investor column in Saturday morning’s Wall Street Journal. Five minutes changed how I think about investing forever.

The nominal premise of the column is to review two books, Safety Net by James K. Glassman (co-author of the 1999 tome Dow 36,000) and also The Most Important Thing by Howard Marks.

Glassman says the asset classes he recommended in 1999 were wrong, but now he has it right. Either way, stocks are better investments than bonds in the long run.

Marks disagrees. We all know about avoid market bubbles, but the implications are more invidious than that. As Zweig summarizes Marks:

Riskier assets don't necessarily offer higher returns, Mr. Marks says; they only appear to do so. "It's really simple," he says. "If risky investments could be counted on for higher returns, then they wouldn't be risky. And if investments weren't risky, then they probably wouldn't appear to promise higher returns."

By chasing the potential for higher return in riskier assets, investors drive prices up. Under the classic definition of risk—how widely the returns deviate from the average—that alone doesn't make assets more dangerous. But by Mr. Marks's common-sense definition of risk—"the likelihood of losing money"—rising prices are pure investment poison. The higher and faster prices go up, the farther and harder they have to fall.

It’s easy to find an example of this. In the 1990s US stocks exploded, while in the 2000s the market went sideways for a decade. Are the businesses less attractive as going concerns? No, what’s changed is the market sentiment.

The (Nobel prize-winning) capital asset pricing model — calculating risk-adjusted returns — assumed that riskier investments will be discounted and thus provide a bigger potential upside. Marks says that only works if market sentiment hasn’t pushed up the price of that investment (or investment class).

So theories of efficient markets, risk-adjusted returns, and modern portfolios have to take a back seat to a much simpler and older investment theory.

Buy low, sell high.

In other word, go back to Dogs of the Dow, Value Line, or other value-based investment strategies. That means missing the run-up in Apple shares (other than the first few years of Jobs II), but also not riding Microsoft, Intel and Nokia down over the past decade.

Nokia and Microsoft: winners and losers

There is plenty to say about Nokia’s decision to phase out Symbian in favor of the-operating-system-formerly-known-as-Windows-Mobile.

Nokia CEO (and Microsoft veteran) Stephen Elop had already prepared the troops with his “burning platforms” memo, lambasting his new employer for how it failed to respond to the iPhone and Android challenge.

Nokia’s problem is that it never got software. It created Symbian so that it Microsoft would never take over handset profits the way it did on the PC. It outsourced key software development to Symbian and then continued to peddle its cursor-key S60 platform the in the face of Apple’s groundbreaking GUI phone.

Now it has partnered with Microsoft, a company that certainly is competent at software, but has yet to prove that it can execute on mobile software. Elop has jumped off the burning oil platform into a ship that’s adrift and has a hold filled with water. (Today its stock fell 13% in response to the news.)

Who are the winners and losers?

Winners

• Microsoft. Even if Windows Phone never goes anywhere, it gets a user base for Bing on the handset.

Losers

• Nokia. Despited hundreds of millions in side payments from Microsoft, it transitions from the world’s most popular smartphone platform of the past decade (albeit one in sharp decline) to the 5th most popular platform. It adopts Windows Phone 7, which has a 2% share in the US smartphone market, half that of the older Windows Mobile 6.
• Symbian and MeeGo developers. After following Nokia in its QT-everywhere strategy, they are now officially orphaned.
• Current Windows handset vendors. Presumably Windows Phone becomes a captive Nokia platform (the only kind it likes) and Samsung, Motorola and Sony Ericsson abandon their limited sales of Windows phones into US enterprises.
• Research in Motion. The distant and long-rumored hope of a Microsoft acquisition as an exit strategy is now gone.
• European network operators. Instead of key mobile Internet decisions — APIs, apps, app stores, search, bundled apps — being made by two American companies, they now will be made by (at best) three American companies.

Meanwhile, the Silicon Valley duo will continue their march forward to displace all comers — Apple with a plurality of profits and Google eventually achieving a majority of the market share.

The sign of a troubled company is multiple Hail Mary passes in a row. Nokia bought Symbian and made a half-hearted effort to establish an open source project (three years too late). It told developers to abandon Symbian APIs in favor of QT APIs that could enable a transition to MeeGo. And now it declares its future to be a platform that many have already written off.

All this because it doesn’t want to join the commodity free-for-all that is Android? In his memo, Elop told his troops

Chinese OEMs are cranking out a device much faster than, as one Nokia employee said only partially in jest, “the time that it takes us to polish a PowerPoint presentation.” They are fast, they are cheap, and they are challenging us.

Nokia needs to fix its execution rather than throwing more Hail Mary passes than even Doug Flutie ever completed.

Update 9am: Michael Mace sees the Nokia-Microsoft tieup as like the Apple-IBM alliance 20 years earlier to create Taligent: similar in that execution will be the key, but different in that today Nokia has bet its future on the success of the alliance.