Google and the Law of Conservation of Attractive Profits

In this blog, I have touched on Clayton Christensen’s “law of conservation of attractive profits” a few times (in Japanese: 1, 2)

The law of conservation of attractive profits is briefly described in Christensen’s book “Seeing What’s Next”. Below is a passage from the book;

We have also called the law of conservation of integration the “law of conservation of attractive profits,” because companies make attractive money when they solve the hardest problems. The hardest technical problems mandate solutions that are tightly coupled integrated systems. When modularity and commoditization cause attractive profits to disappear at one stage in the value chain, conservation of integration means the opportunity to earn attractive profits with propriety products will emerge at an adjacent stage.

Conservation of integration explains why it is not accurate to characterize and industry as integrated or disintegrated. There are numerous types of integration in any given industry. Specialists are integrated, just in different ways. Whereas integrated firms might span an entire industry’s value chain, specialist firms might be integrated to produce a single component that itself is not good enough. Or they could be integrated across whatever interfaces drive customization and convenience, which could be the point of customer interaction or the interface with suppliers.

I find that the law of conservation of attractive profits gives us great insight into how personal computing evolved from computers like the Apple II to the iPhone. This is a long topic, and I hope to touch on it sometime in the future.

For the current discussion, I would like to touch on how Google seems to be trying to manipulate the smartphone value chain and whether it will succeed.

To understand the current situation better, I suggest readers listen to two excellent podcasts which describe the different strategies that Apple and Google are pursuing.

  1. Cubed Podcast: “Google I/O Takeaways and Implications”
  2. Tech.pinions Podcast: “Google I/O, 4K, GoPro”

Regarding Google, what is suggested in these podcasts is that Google is trying to commoditize both hardware and software so that their services will reach the widest audience possible, thereby providing Google with data to feed their machine learning project. They do not seem to care about creating an ecosystem in which their hardware OEMs and application developers can sustain profitable businesses.

Viewed from the law of conservation of attractive profits, this can be explained as Google attempting to commoditize hardware and software, so that the service layer will dominate attractive profits.

The question is, will this work?

Listening to Ben Bajarin in the Tech.pinions Podcast, it dawned on me that there is another layer that actually has a bigger chance than Google of gaining the attractive profits. That is the carrier layer.

Carriers have the following advantages;

  1. Carriers are the interface to customers, and importantly, they control the billing, especially in emerging countries.
  2. Carriers own the pipe and can control the flow of content through their networks. For example, they can provide unlimited access to WhatsApp and Facebook, while restricting access to YouTube and other sites.
  3. Carriers are local. This means that they can tailor pricing and promotions to fit the local situation. This is especially important in emerging countries where the spending power of the average citizen is a fraction of that in developed nations.
  4. Before the introduction of the iPhone, carriers had huge power in the ecosystem. So much so that Steve Jobs famously called them “orifices”. It has already been proved that the market structure is such that carriers can command huge profits if the circumstances are right.

Ben Bajarin briefly touched on Cherry Mobile in the Philippines, which is a carrier that is selling its own brand of smartphones.

I am not yet familiar with what Cherry Mobile is actually doing, nor have I spent time thinking about this in more detail. It does appear however, that Google is not the only potential beneficiary from software and hardware commoditization. In fact, it seems totally possible that services will also be commoditized and that the carriers will reap the attractive profits.

This is a theme that I will continue to think and hopefully write about.

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