Mobile Platforms: Integrating Everything

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Paul Sagawa / ArturPylak

203.901.1633 / 203.901.1634

sagawa@ / apylak@ssrllc.com

August 24, 2011

Mobile Platforms: Integrating Everything

  • The days of stand-alone devices may soon be behind us, as mobile platforms integrate functionality into a seamless experience across access venues. Consumers will access profiles, applications and content in a consistent and intuitive manner whether via smartphone, tablet, desktop computer, or living room television. At the heart of this are a panoply of cloud-based applications that will become increasingly interlinked, encouraging tighter integration into the platform and interplay across devices. Against this backdrop, Google and Apple control opposing platforms that will vie for dominance, with Microsoft a viable dark horse candidate for meaningful share. Stand alone internet services are at long term risk to the manifest destiny of the platforms– like packaged PC software vendors during the salad days of Windows – unless they have defensible advantages. Similarly, hardware OEMs will find that strict interoperability with the cloud-extended platforms squeezes degrees of freedom for differentiation, and could lose ground to captive or favored rivals with closer hardware/software integration
  • First: smartphones. Next: tablets. Now: cloud-based lockers for storing and sharing personal files (images, audio, video, documents, etc.). Meanwhile, Apple and Google sniff around ways to co-opt the living room TV to their ends, an increasingly viable proposition considering the growing penetration of connected home electronics. The end game is clear – tie devices together into an integrated environment with a common interface paradigm and seamless access to applications and content, offering consumers new functionality and flexibility while erecting enormous barriers to competition, particularly from stand alone devices not tied to a platform ecosystem
  • iOS and Android are the obvious platform leaders, although they have strikingly different approaches. Apple’s tight control gives it an advantage in the integration and ease of use of its products, while Google’s inclusiveness allows it to be faster to market with far broader range. Thus far, Google’s approach has given it a better than 2 to 1 share lead in smartphones, and positions it overtake the dominant iPad as Android tablet implementations improve. HP’s abrupt withdrawal from WebOS, and RIMMs struggles with its iconoclastic Playbook are testaments to the futility of stand-alone approaches. Meanwhile, we believe that Microsoft’s Windows 8/Windows Phone – a well designed platform with a strong, dedicated ecosystem – will emerge as a viable third alternative
  • The integration of platforms across devices will enable new cloud based applications functionality and spur additional integration of applications into platforms. Categorizing applications into 5 basic groups: general internet, location based services, distributed content, rich media, user generated content, e-commerce and productivity, we see examples in each area of once stand alone applications that are being co-opted by the major platforms – unified messaging, navigation, news alerts, audio streaming, social networking, shopping, document processing, etc.. This phenomenon is reminiscent of the integration of functionality into Windows during the ‘90’s, which laid waste to the packaged software market
  • We believe that only applications that are truly differentiated and that have built critical mass are safe from the coming wave of platform integration. The obvious examples are Amazon, with its e-tail business and Facebook, with its 750 million strong user base. Some less powerful franchises are already under pressure – Yahoo e-mail, Garmin navigation, Shutterfly photo editing and management – and others seem at risk from integrated competition – e.g. PayPal (Google Wallet), Groupon (Google Offers), and Pandora (Apple Genius). Amongst the dozens of “Web 2.0” companies, we believe that Twitter and OpenTable may have achieved sufficient differentiation and critical mass to survive competition from platform-integrated applications, but that the rest have not
  • To date, Android licensees have been given liberty to customize the software in pursuit of differentiation for the manufacturer, but at the cost of fragmentation that hampers the ecosystem. We expect that these degrees of freedom will tighten and that future device differentiation will be hardware based. Ultimately, we expect the frantic evolution of device specifications to slow, pressuring margins and rewarding scale and efficiency. The same effect will be true for Microsoft licensees, while Apple will be pressed to sustain its current device cost advantages vs. the two competing ecosystems
  • In the near term, Apple, with its closed system, enjoys the advantage of tight integration between hardware and software design. While we believe the benefits of this will lessen over time, Google’s recent acquisition of Motorola Mobility raises the question as to whether it will counter by tightening the integration of its software with its new device business, potentially to the detriment of its partners. We expect Google to offer unequivocal support to its OEMs and repudiate favoritism to its in house hardware, although it will clearly retain the option value of reversing that policy if it sees fit. We do expect Google-owned Motorola to become a champion for innovations favored by its parent, such as Google Wallet and Google+
  • In summary, we expect mobile device platforms to extend their hold across multiple device categories, establishing consistent environments through which consumers will access the large majority of their applications. Consumers will benefit from powerful integration across access devices and between applications, but will face very high switching costs. Platform owners, Google, Apple and likely, Microsoft, will capture ever greater value by displacing stand-alone applications with versions integrated to their platforms, to the extent possible. Only applications with sustainable differentiation and critical mass, such as Amazon e-tail or Facebook, will be resistant to this phenomenon. Meanwhile, device OEMs will cope with increasing commoditization as user value shifts to the platform and integrated cloud-based applications

In the Beginning, There Were Devices…

Today, buying a smartphone is a stand-alone decision. You don’t have to have an Apple iMac to buy an iPhone or a Windows PC to buy a Windows phone. It certainly doesn’t matter what type of TV you own or which video game console your kids use. Most of your favorite on-line applications are available as apps on most mobile devices, and, for the most part, your device doesn’t dictate which one you should use and the applications don’t really interact much with each other. Content – e.g. photos, songs, video, etc. – is shuttled between the device and storage on the home computer. It is no big deal if your spouse is an Android user and you prefer iPhone or Windows Phone 7.

All of this is changing. Apple’s June 6 announcement of its upcoming iCloud service is emblematic of the change. iCloud will create a central, on-line repository of content – photos, music, video, applications, documents, schedules, etc. – that can be accessed and edited from many devices. Take a picture with your smartphone camera and it is automatically pushed to the cloud, where it can be seen by your family. Similarly, calendar updates, app upgrades and other information can be pushed wirelessly to all devices – smartphones, tablets, computers, etc. – keeping everyone on the same page. Suddenly, it does matter what sort of device your spouse carries.

Of course, Apple is not alone in this concept. Microsoft offers its SkyDrive consumer cloud service with very similar capabilities as iCloud, and will integrate it with its Windows Phone platform with the next major update. Google has begun a beta trial – N.B. most Google services are launched as beta trials – of a Locker service to store music and other files, although it is currently limited in functionality. Expect a relentless stream of incremental service releases to close the gap with Apple and Microsoft (and probably raise the bar along the way). While these services all purportedly work across vendors, they are being tightly integrated, and thus will work better, with the company owned platform.

By tying the platform to services that are hosted on the web and available to users across multiple devices, Google, Apple and Microsoft are changing the basis of the consumer purchase decision away from the specifications of the device itself and toward the experience enabled by the combination of devices and services. Switching costs rise and the impetus to by other devices from the company increases as well.

Today, the Pocket. Tomorrow, the TV.

For the moment, Android, iOS and Windows Phone 7 and their emerging cloud experiences are really just for smartphones, tablets and home computers. However, the cloud is rapidly heading toward the living room. Increasingly, home electronics are connected to the Internet (Exhibit 1).

Most new televisions, Blu-Ray players, and game consoles now come with WiFi or hardwire interfaces, and even some kitchen appliances are connected. These devices will be corralled into the integrated platform experience.

Microsoft has established the first beachhead with its Xbox game console, which is connected and has deals with Netflix and others to stream video content to the home (Exhibit 2). It would be natural for Microsoft to link its SkyDrive services to the Xbox and to morph its operating environment to a Windows Phone compatible OS. Apple has been dabbling in TV for five years with its AppleTV offering, which is closely tied to the iTunes interface familiar to Mac and iPhone users. Rumors abound that the company will soon offer fully iOS compatible televisions. Finally, Google has fumbled its forays into the living room, with the GoogleTV debacle a fresh memory. However, the Motorola acquisition instantly makes it the largest supplier of Cable set-top-boxes, ripe for Android and internet connectivity.

Pulling the living room TV onto the integrated mobile device platform will open a further range of user experiences, allowing control of and interaction with content displayed for more than individual use. Internet delivered video could be supplemented by supplementary material, such as replays, alternative views, background information, or related advertising, displayed on smartphones or tablets (Exhibit 3). Gaming experiences could be made richer via multiple screens – a concept embraced by Nintendo with its recently announced Wii U controller. The frustrating cable remote could be replaced by an easy to use app on a touch screen smartphone or tablet. Steaming video could be easily transferred to a portable device mid-stream and carried to another room, or even completely out of the home. All of this will make mobile platforms all the more valuable, while raising the switching costs for consumers.

Apple is All About the Integrated Experience

The idea of extending a consumer device platform into the network to create a broader solution for users, and thus, higher switching barriers, has been an aim of mobile phone makers for many years. However, Apple was really the first to deliver. The first iPhone was synched against software profiles maintained on a home computer – preferably a Mac – in the same way that iPod users downloaded songs and managed play lists before synching them to their device. By the second generation iPhone, Apple had embraced over the air synching, and the announced iCloud service should make the home computer a fairly superfluous element of the iPhone experience.

From the get go, the iPhone integrated its dominant iTunes music distribution service into its platform, tying its apps store to the site. Apple’s own browser, calendaring and messaging applications, music player, FaceTime video calling app, and photo viewer/editor are integrated into iOS as default settings, along with a few 3rd party applications, notably, Google’s search, navigation, YouTube, and finance applications. Moreover, Apple controls application and media access through its app store, music store and newsstand services. It is a hallmark of Apple’s strategy to maintain a tight rein on its ecosystem and its vision of the user experience.

With the successful April 2010 introduction of the iPad tablet, Apple has extended its experience to a new form factor, one optimized for media viewing and other non-keyboard intensive cloud applications. The recently announced iCloud will cement the interrelatedness of smartphones, tablets and home computers. Eventually, we expect Apple to successfully tie the living room TV into this experience, although the reception to its initial AppleTV efforts has been less than overwhelming.

Google is All About its Ecosystem – and Speed

Obviously, the second platform is Google’s Android, which has run to the market share lead on the strength of its open architecture and enthusiastic ecosystem of partners (Exhibit 4). This approach has led to a more haphazard experience for Android users – device makers may alter the user experience through their own software overlays, leading to some incompatibility for applications across devices – but has spurred a vibrant ethos of innovation around the platform. The Android ecosystem results in more frequent platform updates, earlier introduction of new hardware/software capabilities, and a broader range of products. Like Apple, Google has integrated several applications to the platform as default – Google Search, Maps, Navigation, Gmail, Calendar, Voice Commands, and YouTube are all default apps on Android and well integrated into the experience. We also note that Google’s huge investment in a massively distributed data processing infrastructure connected by its own fiber network gives Google applications a significant advantage in speed and reliability, likely to be an important leg up for Android as the cloud experience becomes an ever more important element of consumer decision.

Android’s extraordinary strength in smartphones has not yet translated to momentum in tablets, largely because of Apple’s headstart and the inadequacy of the first round of Android tablets based on a software version that had not been specifically tailored to the capabilities of the larger screen device. The second round of tablets based on a subsequent software release began shipping in earnest during the past quarter, and a further software update should appear on products destined for retail shelves in the Christmas season. The relative success of these tablets will be a more telling data point on the potential future trajectory of Android in this category. However, we believe the ultimate driver for Android tablet adoption will be the shift of buying behaviors from devices to experiences, with user synergies between smartphones, tablets and other devices. In the long run, we expect Android tablets to overtake iPads, despite Apple’s current product cost advantages (Exhibit 5).

Google, too, has designs on the living room. Google TV was an utter failure, as media networks blocked access to content from the devices. Nonetheless, YouTube is the largest streaming video source on the internet, with a growing paid content business and designs on producing original content for the service (Exhibit 6). With the acquisition of Motorola Mobility, Google will become the largest supplier of set-top-boxes to the global cable industry. While Google will have to step lightly to avoid open conflict, it will at least have the opportunity to introduce its Android operating environment and non-video internet applications to the platform, as well as helping to shape the transition of video delivery from strictly channelized feeds to something more interactive.

There IS Another

HP has thrown in the towel on WebOS. Research in Motion persists with its Playbook platform despite the disappointing reception to its would-be iPad challenger. Are we destined for an Apple/Google duopoly? We don’t think so.

We believe Microsoft is likely to be the third player for several reasons. First, Microsoft’s Windows Phone 7 and Windows 8 are strong software products with an alternative look and feel to the similar Android and iOS and functional advantage in managing multitasking. Second, Microsoft, unlike HP or RIM, has a range of strong next generation web capabilities that it can integrate into its cross-device cloud experience. Bing, Hotmail, Exchange, Office 365, Skype, desktop virtualization, and web hosting are all valuable chips. Third, device makers and wireless carriers – key market influencers all – are uncomfortable with the prospects of a duopoly and will enthusiastically support Microsoft’s efforts, building good products based on Windows Phone and putting them on the shelves. Fourth, Microsoft has a pretty good ecosystem itself. Four of the world’s top six smartphone makers are Windows licensees – Apple and RIM are the obvious holdouts. Fifth, Nokia is a far better partner than most investors realize. Nokia may have shot itself in the foot by stubbornly insisting on its own tragically flawed smartphone software program, but it remains a leading brand in emerging markets, a force in distribution, a strong hardware designer, and a low cost manufacturer. It is also a proud culture intent on redeeming itself. Finally, Microsoft will have an advantage once the business market belatedly bellies to the mobile platform bar. All in all, we believe a compelling case for Mister Softee.

Absorbing the Apps

The integration of applications and device platforms is a powerful force. From the early days of the iPod, Apple has made it easier for its customers to buy their music from iTunes rather than from alternative sources, and its customers have responded by giving Apple 70% share of all U.S. music downloads. Android integrates Google Maps, which in turn, has begun to integrate Google Places. When you look at a map on your Android smartphone, most local businesses are indicated – click on one and get a page of information on the business, an opportunity for Google to serve paid advertising, including special deals.

We believe that the integrated device/cloud platforms will eventually subsume most applications. Of course, there is precedent for this. Microsoft Word and Excel, the lynchpins of the company’s powerhouse Office franchise, were first popular on the Apple MacIntosh. For five years, Microsoft held back from porting the popular productivity programs to Windows, fueling the false hopes of the developer community that Bill Gates and company would not vacuum up the burgeoning PC applications business. Subsequently, word processing, spreadsheet, presentation graphics, calendar management, print management, network management, messaging, and browsing, amongst other functions, became tightly tied, often bundled and sometimes fully integrated, with Windows (Exhibit 7). Given Microsoft’s domination of the PC platform business, anti-trust regulators in the US and Europe eventually intervened, but not until after the death of many of the pioneers of PC software (Exhibit 8).

The same process is underway in cloud-based apps. Google offers browsing, search, maps/navigation, voice recognition, calendar, and messaging integrated into Android, with a bevy of well tuned add-ons, such as music, YouTube, books, documents, finance, social networking (Google+), video conferencing, and translation, amongst others, available as downloaded apps. Apple’s iOS bundles music, media player, video conferencing, calendar, messaging, and other homegrown apps, and is a threat to integrate many more. Microsoft recently purchased Skype to add video calling to its own suite of web based services – e.g. search, messaging, document processing, etc. – that can be integrated to Mobile Windows.

31-derful Application Categories

We have identified 31 categories of consumer device applications, parsed amongst five basic groupings (Exhibit 9). Much of the General Internet group, which includes browsing, search and various forms of messaging, is already absorbed into mobile platforms. Even text messaging, that cash cow fiercely guarded by carriers, is at risk to instant messaging concepts in development by Apple, Google and Facebook.

Location-aware applications, which proceed from positioning information provided by GPS and cellular triangulation, are also seeing rapid integration. In particular, Google has made maps and navigation a centerpiece of their Android experience, layering directory, traffic and even weather information directly onto their electronic maps. Within this grouping, we anticipate NFC-based mobile payments to become the next battleground, with existing payments players – i.e. credit card networks, local banks, etc. – pressured by solutions integrated directly into mobile platforms.

The tools for accessing and consuming produced internet-based content – e.g. media players, e-readers, translation programs, etc. – are clear candidates for platform integration. The content itself – e.g. news, e-books, sports information, etc. – is subject to source scarcity and branded aggregation that could forestall easy integration. Similarly, streaming media, both audio and video, are based on copyright protected content that is often controlled and aggregated by media publishers with substantial barriers to entry. However, given the breadth of the content market and the rivalries amongst publishers, we expect platforms to establish an important integrated role in facilitating the search for content for users and managing transactions for studios and publishers.

User generated content is another important category. Already elements like video calling (Facetime, Skype, etc.) have been integrated into basic platforms, while image/video management is a key element of the recently announced cloud services. Generally, we believe tools that enable the creation of user generated content, such as video and photo editing suites, will be fair game to be integrated, while services that facilitate the distribution of user generated content, typically social networking, are likely to prove very robust once critical mass is achieved. Document processing, including traditional productivity suites, is a fairly mature category where Microsoft’s longstanding domination may make the category more resistant to integration by other platform operators.

Gaming straddles the produced content and user generated content categories. At one extreme, gaming may be published programs sold and distributed over the web, but played on a user device, while at the other, a game may consist of a massive community that interacts entirely within the context of a social network. The creative aspect of gaming (and the associated copyrights) suggest that the value will reside with publishers, but we note that platform owners have traditionally extracted rents by licensing access to proprietary consoles or social networks.

Finally, e-commerce is a huge category, typically with significant economies of scale. Amazon casts a huge shadow over the space, but emerging niche markets, such as the hot “daily” deals business (Groupon, LivingSocial, Gilt), on-line dating (Match.com, eHarmony) or on-line restaurant reservations (OpenTable) still represent opportunities for relative newcomers to establish critical mass. Internet travel agencies are an interesting test case – arguably, incumbent players Expedia, Orbitz, Travelocity and Priceline have established critical mass and negotiated relationships with airlines, hotel chains, and rental car agencies that should be formidable barriers to entry. Nonetheless, Google, with its recent purchase of ITA software, has taken leadership in the underlying software used by on-line travel agencies to parse pricing by travel suppliers. While it is obligated by the terms of its DOJ review to provide ITA’s services to competitors on a non-discriminatory basis through 2016, it does signal a longer term intention to muscle into the larger travel space.

Is Anyone Safe?!

Assessing the universe of applications, we believe that those that are applicable to a broad base of consumers will eventually be integrated unless independent leaders have established both critical mass and sustainable barriers to competition (Exhibit 10). For example, Amazon has built enormous cost advantage in its e-commerce business along with a very large and satisfied customer base, making it an unlikely candidate to suffer from the integration of e-commerce into mobile platforms. If anything, Amazon is a threat to continue to aggregate additional categories of retail products into its successful business system through either acquisition or conquest. Mobile platform operators will need to work with Amazon, rather than around them. Similarly, Facebook and its 750 million strong user base is probably not in real danger from integrated social networking platforms, as interesting as Google+ may be. We consider these large, entrenched services as tent-pole apps that will have to be supported on all platforms.

On the flip side, newly public Pandora would seem highly vulnerable to the integration of streaming audio into platforms, or even into tent-pole applications like Amazon. The same for daily deals programs like Groupon and LivingSocial. At the very least we would expect notifications for deals to be aggregated and screened by platforms, exposing the originating deals service to harsh competition. Of the recent run of issued and rumored “Web 2.0” IPOs, we see Facebook, OpenTable and Twitter as having the most defensible market positions, while we are skeptical about LinkedIn, Zynga and Netflix, along with Pandora, Groupon and LivingSocial.

We Can Build it

The breakneck pace of device innovation and the degrees of freedom offered Android licensees by Google has yielded rich opportunity for differentiation by device manufacturers. In particular, Samsung and HTC have thrived, building scale economies and brand premiums in the process. The near term offers more of the same, albeit with building pressure to bring brand specific software overlays into stricter compatibility with the generic Android standard. Longer term, the pace of hardware innovation will inevitably slow increasing the inherent commoditization of device manufacturing and weakening product differentiation. Ultimately, independent device brands may suffer a squeeze.

As the market trends toward this end, Google will be increasingly tempted to push tighter integration of its software platform into hardware designs, likely favoring devices manufactured by its pending Motorola acquisition. At the very least, we believe Google will use Motorola to champion integrated functionality to benefit the larger Android experience – such as Google Wallet (mobile payments) or Locker functionality.

Winners and Losers

Obviously, we believe Apple and Google will both be long run winners as devices become pieces in a larger consumer experience (Exhibit 11). Given its potential as a third viable platform, we would put Microsoft in the same category. Amongst applications providers, Amazon and Facebook are also clear winners, with Twitter, OpenTable, and IAC apparently well positioned. While we haven’t addressed it in detail with this call, we also see wireless semiconductor vendors, such as Qualcomm, ARM holdings, Broadcom, Nvidia, Skyworks, RFMD, Avago, and Triquint as advantaged by these trends. Leading OEMs Samsung and HTC will benefit from their design leadership within the Android and Microsoft ecosystems, although we have concerned that both could suffer once the pace of innovation slows several years hence.

On the losing side, we expect Research in Motion’s Playbook platform to follow HP’s WebOS into oblivion, with both companies damaged by their inability to muster an integrated experience for consumers or gain the support of a broader ecosystem of partners. We are also concerned that the growth expectations for many web-based applications do not reflect the potential for competition from platform integrated alternatives, with high flyers like Groupon, LivingSocial, LinkedIn, Pandora and others at risk.

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