Naofumi Kagami

Will Attractive Profits in the Android Ecosystem Move to Component Makers?

In a previous post, I discussed that Clayton Christensen’s “Law of Conservation of Attractive Profits” predicts that attractive profits will move from the Android OEMs towards adjacent layers in the value change.

One possible layer is the SoC component manufacturers. I am very unfamiliar with this market, but I think that in this market, Qualcomm has historically been very strong with its Snapdragon series of chipsets. The new rising star is MediaTek which is very popular among the new OEMs like Xiaomi and MicroMax which sell their smartphones at very low costs. It seems like the rise of MediaTek is recently pressuring Qualcomm.

Unlike the Smartphone OEMs, many of which are having trouble generating profits, Qualcomm and MediaTek are quite profitable. Apparently due to its focus on emerging markets, MediaTek’s revenue growth is quite remarkable, up 62.7% year-on-year.

Whether or not the SoC component layer will earn attractive profits depends on the structure of the market, barrier to entry, capital intensity, commoditization or Android hardware, bargaining power relative to Android OEMs, bargaining power relative to Fabs, etc. It will be fascinating to watch how this market evolves. Unfortunately, I don’t have enough understanding of the market to make a reasonably informed prediction. My gut feeling however is that the situation may eventually resemble the PC market, where Intel owned a huge proportion of the attractive profits.

More on Attractive Profits in the Cloud

I’ve been touching on the subject of commoditization of the cloud a couple of times on this blog(1, 2.

Today, I’ll like to look at the current players and how a possible commoditization of the cloud will affect their businesses. That is to say, do the current players own an adjacent layer in the value chain that can reap the attractive profits.

Barb Darrow at GigaOM, citing Rick Sherlund from Nomura Securities, gave some estimates on which companies are are making money from their cloud business (below). It is clear that Amazon AWS is losing it’s position as the dominant cloud vendor. The other companies, Salesforce, Microsoft, IBM and Google are significantly narrowing the gap. Microsoft and IBM in particular have very high growth rates relative to AWS.

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Given that cloud services are in many ways similar to rental servers, and that it is probably difficult to maintain differentiation, it is likely that prices will drop and cloud services will commoditize. When commoditization happens, Christensen’s “law of conservation of attractive profits” predicts that the attractive profits will shift to an adjacent layer in the value chain. Here I would like to see if the current players in this market will be able to capture the profits as they shift.

Microsoft, IBM: Both of these companies are very strong in enterprise IT. As the cloud commoditize and enterprises move their data centers into the cloud, Microsoft and IBM could easily provide value through consultation and customized services. They are both well positioned to take advantage of cloud commoditization.
Salesforce: Similar to Microsoft and IBM, Salesforce will benefit through consultation and customization for the cloud services.
Amazon: I can’t see any of Amazon’s strengths in the layers adjacent to the cloud. I don’t see them benefiting at all from commoditization of the cloud.
Google: Google makes almost all of it’s money from advertising, and it doesn’t make much money (at least not directly) from other activities. Hence it is difficult to say whether they are capturing profit or not in any of their activities other than search. Likewise, it is difficult to discuss how the commoditization of the cloud will affect them.

Understanding Microsoft’s Business

Jan Dawson recently broke down Microsoft’s revenue and growth by business segments. This helped me to understand the significance of the enterprise segment and at least partially understand the direction in which it is moving.

Points that caught my eye;

Windows revenue is dominated by sales through OEMs. “Windows OEM revenue” is 15.5% of total whereas “Retail and other sales of Windows” is only 0.5%. This means that very few consumers upgrade Windows themselves, and continue to use the OS that shipped with their machine. This suggests consumers are indifferent about the new features provided with new Windows versions. When you think about the new features in Mac OS Yosemite, you realize that a lot of these are actually about integration with iOS devices and not about Mac OS X itself. It’s something worth thinking about.
Consumer Office revenue (3.0% of total) is puny compared to Commercial Office revenue (25.0% of total). Although this may suggest that Google Docs is dominating in the consumer space, I think this may also suggest that consumers don’t really use Office suites very much. I have seen very little data strongly supporting either possibility.
Server products are really quite strong. It’s amazing that sales continue to rise despite the rise of cloud computing. I would really like to understand what is happening here, and whether this strength will continue.

Why I Think Zero Rating is Good

I have previously written about the rapid rise of “zero-rating”, that is the practice of carriers providing free access to specific web-sites or Internet services, but charging for access to other sites.

This is in direct conflict with the net neutrality ideology which argues that (citing wikipedia);

Internet service providers and governments should treat all data on the Internet equally, not discriminating or charging differentially by user, content, site, platform, application, type of attached equipment, and modes of communication.

Just recently, the Internet.org initiative sponsored by Facebook released an app for “zero-rating”. Through this app or the Facebook app, customers of Bharti Airtel’s Zambian subsidiary will be able to access the following services with free data charges.

Facebook and Messenger
Wikipedia
AccuWeather
Google Search (Search only. Data will be charged if you click a link to go to another site).
Local services such as job portals.
The women’s rights app WRAPP.
A basic library of Zambian laws.

I really like the selection. It is so noble.

If I was somebody like Nelson Mandela, someone who was working hard to bring democracy, freedom and equality to Africa, I would probably select the exact same services.

At least for our children, I’m sure most parents would choose something similar to the above selection over the commercialism driven “net-neutral” Internet.

As these “zero-rating” data plans become more popular, we can expect many more services coming on board. I hope that Facebook and the carriers will manage to resist the lure of commercialism, and continue to select the good ones and reject the bad ones based on a high ethical standard.

How the Automobile Industry Can Be Disrupted

I recently wrote why Tesla is not a disruptive innovation. Here, I would like to refer to an example that is disruptive.

“A window into China’s low-speed electric vehicle revolution”

This article by Charlie Paglee describes low-speed electric vehicles, which do not have the safety or comfort features of regular automobiles and sell from 2,000 USD. More than 200,000 have been sold in 2013. Tesla, on the other had, sold only about 20,000 in the same period.

Important points which suggest that these low-speed electric vehicles are much more disruptive than Tesla;

Cheap (sell from 2,000 USD).
Simple manufacturing procedures requiring little capital investment.
Limited features. Slow max speed (38 mph), short range (60-100 miles).
Sustainable business even without government subsidies (or massive injections of venture capital).
Devoid of safety features required of regular automobiles.

One important thing to note is that the automobile ecosystem depends on a lot of infrastructure. For example, filling stations and roads. An equally important component of the ecosystem is the distance between destinations. For example in Japan, an EV would be good if it could travel to the nearest railway station (maybe equivalent of a 30 minute walk), whereas in the U.S., a car needs to travel the distance of the whole commute. Therefore, the disruptive potential will vary depending on the local ecosystem.

Amazon’s Hardware Strategy Mystery

Ben Bajarin recently tweeted a chart showing how tablet market shares have changed since 2011.

BenBajarin 2014 7月 25

In Ben’s tweet, he noted how Amazon’s market share has now become very small, and that is certainly true. Although Amazon’s share tends to rise sharply in the holiday season and we can still expect another bump in Q4 of this year, 14Q2 is seeing very very small sales for Amazon.

At this point in time, I think that it is worthwhile to review how Amazon started selling the Kindle Fire, and how its strategy has unfolded.

The Kindle Fire launched in 11Q4 at a very low price of $199 (compared to $499 for the iPad) which was only possible because Amazon subsidized the price.
The Kindle Fire was the catalyst that showed how Android tablets could take market share away from Apple. Up till then, companies like Dell and HP had tried to compete with Apple without any noticeable consequences. The extremely low cost of the Kindle Fire finally allowed Android tablets to start expanding market share, and it became obvious that Android tablets had to be priced in this domain if they were to ever sell well.
The Kindle Fire was a low-end device and omitted many features that were present in the competition.
The success of the Kindle Fire demonstrated for the fast time that Android tablets could compete against the iPad under the condition that the price was kept under 200 USDb (many Android tablets had previously tried to enter the market, but all had failed).
In particular, Google’s Nexus 7, which was released in July 2012, was obviously designed to match the successful formula that the Kindle Fire had pioneered; a 7-inch screen and a price below 200 USD. The Nexus 7 shows up in Asus sales in Ben’s chart, which was significantly elevated since 12Q3.
Amazon released the second generation of the Kindle Fire in 12Q4 with a price reduction to $159. They also released two higher-spec versions, the Kindle Fire HD priced at $199 and $299. With these updates, Amazon saw market share similar to what they saw with the first version.
Amazon released the third generation in 4Q13 for 139 USD, again together with two higher-spec models ($229 and $379). Amazon again saw good sales in the holiday season, but sales dramatically dropped in the next year according to Ben’s chart.
Importantly, the Nexus line of tablets (produced by Asus) also lost steam after the initial introduction.
The only branded tablet that saw an increase in market share during this period was Samsung. Although I cannot find pubic data that explains Samsung’s rise, it is likely that Samsung’s sales were the result of bundling with smartphones and possibly TVs; they weren’t selling by themselves and people got them even when they didn’t really want them.

We can clearly see that despite initial expectations, the Kindle Fire tablets have not really grown to be a strong contender in the tablet market. This is also true of the Nexus 7 lineup. The question is, could Amazon have done better?

We know that a large part of the “others” in Ben’s chart are non-branded tablets, which are generally very cheap, low quality and come out of the Chinese technology ecosystem. These have been selling mostly for watching video. Samsung’s sales also come from bundling which means that the cost to the consumer is very low or maybe even free. What this means is that although the Kindle Fire was just about the cheapest usable tablet when it debuted, that is no longer the case. Kindle Fire languished because it was no longer the cheapest tablet that was barely usable.

This suggests that Amazon could have done better with the Kindle Fire if they had continued to pursue their low-end strategy. Instead of moving up-market with the Kindle Fire HD and HDX, they could have instead gone lower into possibly sub-100 USD price points. They could have even provided the Kindle Fire for free with an Amazon Prime membership subscription. In fact, this is exactly the strategy I had expected Amazon would pursue. I actually wrote a blog post back in October 2011 (in Japanese).

In my old blog post, I expected Amazon to focus on creating a tablet that was so limited in features that the only thing you could do with it was to consume content. I expected that Amazon would continue to omit the camera, mike, gyroscope, and cellular connectivity, because these were not essential for reading books or watching videos. They could even have continued to use Android 2.3 as the base for their OS.

This is not the strategy they pursued. Instead of staying at the bottom, they moved up to the mid-market segment. Even though Amazon’s prices decreased, competitor prices dropped even faster. The Kindle Fire is no longer a product that stands out in price, and as such, it has lost its unique appeal. No wonder that sales are not expanding.

It’s a mystery to me why Amazon is pursuing the mid-market in hardware. If you look at the recently announced Fire phone, they are even trying to sell a high-end phone with a significant profit. My opinion is that aiming for the mid- to high-end does not make any strategic sense for Amazon. I am totally bewildered and I’m suspecting that Jeff Bezos is starting to get confused.

China Telecom Exclusive Partnership to Sell XBox One in China

As I have written before, I am suspecting that the commoditization of smartphone hardware is shifting power to carriers.

Recently we have learned that China Telecom has formed an exclusive partnership with Microsoft to sell the Xbox One in China from September 2014.

I do not have enough knowledge of the market to make any conclusions, but I sense that this is a part of a general trend towards carriers exercising more power over hardware vendors. It will be interesting to see how this story unfolds.

Mobile Payments in Africa

Steven Sinofsky wrote a great post on Re/code describing mobile payments in Africa. There is so much important information in here and I’ll probably have to read it several times to fully appreciate it.

Here, I just want to mention one thing.

That is, “Necessity is the mother of invention”.

Importantly, necessity is very different depending on where you live. If science & technology were essential for invention, then the U.S. would dominate globally. That is not the reality.

Innovation happens everywhere, in places where you least expect it, regardless of technical prowess.

Innovation does not necessarily “trickle-down” from the U.S. In fact, it could trickle-up if we gave it a chance.

Tesla is a Prime Example of Non-Disruptive Innovation: BMWs Response As An Incumbent

Peter Yared posted a article describing BMWs response to Tesla. The article titled “BMW Vs. Tesla: A Real Live Innovator’s Dilemma” itself is very misleading because it implies that either BMW or Tesla is facing the Innovator’s Dilemma as described by Clayton Christensen. In fact, it is a prime example of innovations that do not result in disruption. In his publications, Christensen has clearly outlined innovations that provoke a direct response from the incumbent and which almost always fail to disrupt. The incumbent will usually have vastly more resources at their disposal and will counter the entrant quite effectively.

Anybody who has seriously read any of Christensen’s books on the subject will immediately recognize that Tesla is not a disruptive innovation but a sustaining innovation. Peter Yared seems to be rather misguided because he apparently thinks that Tesla is disruptive. Instead, what Yared’s article is describing is not the process of disruption, but rather a typical example of how an incumbent will respond to an entrant with a new technology. In this context, Yared’s article is actually quite worthwhile.

The takeaway is;

BMW has the following resources to counter attack an entrant if they are willing. The resources that are at their disposal include brand, technology, production scale, and sales & distribution.
Tesla is entering the market in a way that provokes incumbents to directly respond.
In this situation, it is very unlikely that Tesla will win.

As interesting as it is to see a disruption taking place, it is also very instructive to witness an incumbent fending off an entrant.