Four strategies to selling hardware
This week, Apple released the iPhone 5 and Amazon released the Kindle Fire HD. The two announcements showcased how different the business model around hardware can be and how that defines the different strategies each of the players in the market is pursuing.
You are what you come from
Apple is a hardware company. For three decades now, the company has been selected complete hardware systems, with some software running on top of it. Starting with the Apple I, going through the mac, the iPod, and now the iPhone and iPad, Apple has always been, at its core, a company that looked at making money by selling atoms instead of bits.
By comparison, Amazon is a service company. Its business, since its inception, has been as an intermediary, providing a better buying experience to consumers in order to sell them more goods provided to Amazon by third parties. Whether it is books, DVDs, detergent, or music, and movies, Amazon makes money by providing the tools that connects the makers of goods with consumers. While it has a long history of shipping physical goods, the company has been growing its presence in the digital space by providing the most popular destination for ebooks, the second most popular destination for digital music, and one of the top destinations for streaming movies.
Meanwhile, another large player in the space, Google, is coming from an advertising background. To Google, the world is seen through advertising sponsored glasses. In its early days, the company found fortune by providing a more efficient way for companies and people to target and deliver advertising to consumers. Every new software offering it has introduced has been based on a business model of distributing more ads. Even the introduction of Android was as an operating system that would provide enough information to Google that it would allow the company to better target individuals when they were not on their computers.
The last big player in the market is Microsoft, which has always been a software company. From its inception, when Bill Gates worked hard to popularize the idea of buying software to its current days, Microsoft has seen the world through bits-colored spectacles. Core to Microsoft is the idea that it provides useful software that runs on your device (whether PC, phone, or other) and that it should get paid a premium for doing so. Because of this, the company has had a hard time adapting itself to the internet era, when software is running on the web and tends to be subsidized through advertising (an era we could easily name the Google era and the search giant found a way to serve as the monetizing engine for that revolution).
With these different types of DNAs, one can see different types of companies having grown and this can be seen in how they are attacking the new mobile market.
Apple: Make money on hardware
To Apple, the hardware is the thing. The company is clearly intent on making most of the revenue it generates by providing hardware to consumers. Whether it is an iPhone or an iPad, what Apple offers in the mobile world is a device that is beautifully designed and sells for a premium price. However, to assume that the premium price is the only thing that makes the company run is to fail to realize that Apple’s success comes from its ability to eek out every cent it can from its supply chain to its production line.
The company looks to the future and places big bets on hardware components, sometimes announcing multi-year partnerships with vendors to ensure the lowest possible cost on a part. But the company doesn’t look to lowering part costs by compromising quality, it looks to doing so by agreeing to order massive quantities of the parts it needs in exchange for steep discount on the per unit price.
The engineering of its devices is also dictated by the need to find operating efficiencies in order to keep its cost structure as low as possible while at the same time ensuring planned obsolescence so people purchase more devices from them (just think about it, how many iPods have you bought over the years? If you bought more than one, why?)
iTunes, the app store, and other part of the software equation are all holding to pretty low prices when it comes to offerings there and Apple is working very hard to maintain those costs on the low end because it can ensure that users get hooked on buying “cheap” stuff from them, stuff that happens to only run on Apple devices.
At the end of the day, Apple makes its money by selling more hardware and software and its related infrastructure is a necessary evil it puts up with in order to sell more devices.
Microsoft: Software is the key
An amusing thing in the discussion of Microsoft in the mobile space is that it is probably one of the large players that has been in this space the longest. However, its ambition over the years has been in providing software that other hardware makers could implement on their own platform. It is a model that worked well for Microsoft in the PC business, where it because the dominant operating system as hardware became comoditized but it’s a model that does not seem to work for them yet in the current mobile market.
Initially, Microsoft saw its future being held by deep investments in software R&D that would lead the company to providing advanced new features that took advantage of new hardware capabilities. However, as software interactions increasingly moved to the web and many capabilities of desktop software became available within the context of a web browser, Microsoft had trouble adapting to the idea that software prices were in free-fall and that the concept of paid software may be one that is heading towards the trash bins of history. In today’s cloud-based world, subscriptions may be a more apt model and Microsoft, like many other software giant, is struggling to adapt to new models that see revenue as a substantially more dynamic environment.
But the company still looks to its future as a software provider. Today, it sells the Windows Phone software to manufacturers who then integrate it into their own hardware. The consistency of experience from one vendor to the next is something Microsoft is looking to as a potential competitive advantage, just as that consistency when it came to Windows on the desktop helped the company hold on to customers even when they were switching the underlying machines.
But to be able to sell software, a company has to ensure it can find buyers and in a world where the alternative to what Microsoft is selling is decent and free, it’s a much more tricky road to navigate. This is why Microsoft has been suing companies that manufacture Android devices, hoping to extract some patent-related revenues and thus give Android a price other than free. I’m pretty sure you could hear the champagne popping all over Redmond when Apple won its recent case against Samsung for exactly the same reason.
Can Microsoft survive by selling software? Probably not and this is why you are now seeing the company put a toe in the market by introducing some of its own hardware. If they can’t, you will probably see them acquiring Nokia and attempt to become a hardware vendor like Apple.
Rimm: The undecided
As a quick aside, Rimm, the maker of the Blackberry, is a company that can’t make up its mind as to which way it wants to go on that spectrum. The company primarily sells hardware but most of its innovation is in the software stack. As a result, it looks like a company that cannot make up its mind as to whether it wants to be a hardware or a software company. This is a dangerous position as others who have attempted to go down the hardware route without having a strong understanding of either how to create hardware people will demand or provide software integrators are interested in have failed. As a result, the single most important strategic decision the company needs to make is how it intends to make money.
By comparison, the other two strong players in the market are seeing a model where the hardware needs to be sold at or lower than its cost and software is packaged in as free because they see their revenue coming from other sources. And they’re taking slightly different parts on this but ultimately they both share the view that the mobile hardware they are putting in the market is not where the money is but that the money is to be made further down the line by mediating the relationship between the buyers of the hardware and some third party: for Google, that mediation happens through advertising; for Amazon by selling stuff through its Amazon.com store.
Google: Advertising is key
When Google went into the mobile world, it started offering a mobile operating system for free and called it open. Initially, this was aimed at undermining Microsoft’s dominance in the PC world by providing an alternative in the mobile space that would give Google an advantage. Score one for Google’s belief that mobile would eventually displace PCs and its attempt at becoming the dominant force in that space.
To Google, providing this operating system meant that it could gather more data it could use to sell more eyeballs to advertisers. But Apple came along and some of that plan was scuttled. The legacy, however, remained, and anyone who wanted to compete with Apple for that new market (since the iPhone started showing how lucrative it could be) went for the cheapest possible option, which led to a slew of new devices running Android.
With more phones running Android, Google hopes it will get more opportunities to generate revenue through advertising (coupons, as well as direct display and in-app ads) and potentially by becoming a payment system people use. As such Google is looking to place itself as a transaction mediator, where third parties leverage the Google infrastructure to ease awareness and eventually purchases.
Amazon: Buy from us
But Google’s plans are now being undermined by a company that used Google’s own Android system, gave it a fresh coat of paint, and provided an experience that would allow for distribution of inexpensive consumption device. Amazon’s goal, when it comes to its introduction of hardware in the marketplace is not to make money on hardware, software, or even advertising.
Amazon’s goal, put plainly, is to drive more traffic to Amazon’s properties and sell more stuff from Amazon.Amazon is primarily looking to ensure that Amazon users continue being Amazon users and buy everything they can from Amazon. This is why the company offers video streaming and ebook lending bundled with “free” shipping.
If you look at a video stream on Amazon and another one is only a click away for under $5, why would you switch to another provider to watch that paid stream? If you’re listening to music on Amazon’s cloud, why would you bother going to iTunes? If you can get ebooks through another tab, why would you go to Barnes & Noble? If the shopping experience for regular goods is only one tap away, why would you go surf to another store?
At the end of the day, Amazon’s main play in the mobile space is one that ensures that users stay, for the most part, within the confines of Amazon.com’s world. In a way, it’s a play that should appeal to the masses and mirrors the Club Med idea of “go visit another country without having to deal with the annoyance of mingling with the locals, unless you want to.” The value proposition is simple: “you could go to another place than Amazon.com but why should you bother?”
Different paths to success
What these different approaches show is that there may be more than one way to succeed into the hardware business. Yes, Apple has the highest margins; Yes, Android ships more devices. But ultimately, because one company is successful at its implementation is no guarantee that the others will fail (nor is implementing another company’s strategy a guarantee they will succeed).
Buried deep in the assumptions and the road each of the players is taking is a set of assumptions and an amount of expertise at executing on their existing business model and to discount such expertise may be to blind oneself to the realities of the market.