Innovation – Page 8 – Naofumi Kagami

What Are Smartphones Used For?

Given that the majority of time spent on smartphones is in apps, it is appropriate to look at what apps are being downloaded in order to understand what people are actually doing.

Below is a list of top downloads in various countries, taken from App Annie’s statistics (iPhone and Google Play: The list is too long to put on this blog post, so please go App Annie to see all the entries).

You can immediately see that the lists for iOS App Store and Google Play are very different;

Google Play is dominated by messaging and communication applications. Specifically, Facebook, Facebook messenger, WhatsApp, Skype and Instagram.
On the other hand, iPhone users seem to be downloading a lot of other stuff. The top ranking apps are not dominated messaging and communication apps. There are a lot of games and some music apps.

AppAnnie Top Downloads

Now what does this mean? I suspect that this is telling us that Android users as a whole are using their smartphones for the essential tasks and the essential tasks only. By essential tasks, I mean communication. That is after all, what phones are for and what feature phones also did quite well with SMS.

Messaging and communication apps dominate Google Play but it is also certain that iPhone users download these apps too. Hence the dominance of this category on Google Play simply suggests that Android users don’t download much else on average. On the other hand, iPhone users download a lot more so the essential communications apps are lower in the rankings.

For example, App Annie has recently reported that Google Play worldwide quarterly downloads exceeded iOS App Store downloads by around 60 percent. However, Google Play downloads are most likely dominated by the essential messaging and communication apps, with little space left for others. If you are an independent app developer, the Google Play opportunity is probably much much lower than the total downloads number suggests.

What Happens When Hardware Makers Can Make No Profit

It is starting to be quite apparent that smartphone OEMs will no longer be able to earn profits. Ben Bajarin put together an excellent piece (paid article) on this in which he questions;

What is the “product” in the Android ecosystem? Specifically where are the revenue generating opportunities? As the answer inevitably becomes “not hardware”, the product offered must evolve. This is where the basis of competition will shift in the Android ecosystem. This shift will disrupt incumbents and open the doors to new entrants.

This is a typical case of what Clayton Christensen has called “The Law of Conservation of Attractive Profits”. I have described this previously in this blog.

As technology progresses and solves the most pressing problems in smartphones, the profits move away from the hardware assemblers to adjacent stages. Hence the predicament that Samsung now finds itself in. At this point however, it is not yet clear which adjacent stages will reap the profits. In particular, it should stress that is no by no means obvious whether Google services will become this stage or not.

Benedict Evans has also written about this on his blog.

It seems pretty clear now that the Android OEM world is starting to play out pretty much like the PC world. The industry has become unbundled vertically between components, devices, operating system and application software & services. The components are commoditised and OEMs cannot differentiate on software, so they are entering a race to the bottom of cheaper and cheaper and more and more commoditised products, much like the PC industry.

So what we are seeing can be summarized as follows;

Hardware is no longer a profit generating opportunity in the Android ecosystem.
Attractive profits will shift to adjacent stages in the value chain.
We have seen something similar happen before in the PC industry.

Therefore, in order to understand how the Android ecosystem will evolve, it is important to revisit the history of the PC industry and to review what happened when profits could no longer be made in hardware.

There are actually quite a few independent things that happened. Here I would like to highlight “crapware”.

Crapware

Ken Segall describes the situation beautifully;

“Crapware: the search for lost profit”

It was only about three years ago that I attended an advertising meeting with the chief marketer in Dell’s consumer division. He had crafted his plan to meet sales targets for the coming year.

At the proper point in the meeting, Mr. Marketer made mention of the crapware on Dell computers. And yes, he called it crapware. He pointed out that margins being what they were, crapware actually accounted for just about all the profit on each sale. He invited the agency to come up with new suggestions for companies who might want to join the club — and pay Dell for the right to clutter up their PCs just a little more.

…

What’s a smartphone seller to do? Crapware to the rescue!

Mike Jennings reports his crapware findings for PC Pro. In a wide range of Android phones, he found a treasure trove of crapware installed by carriers: multiple app stores, security software, game demos, etc., etc. While you can remove this stuff from PCs with a little effort, not so with smartphones. Most of it is here to stay, installed in such a way that it can’t be removed by the user.

Quite simply, if hardware makers (or carriers) can no longer make profit, crapware will proliferate. Since the attractive profits have moved to the crapware owners, they will be willing to pay to have their stuff put in front of customers.

Free Wireless Data For Specific Apps

In many countries now, carriers are exempting certain apps from data charges. For example, even if you are on a pay-as-you-go data plan, the data that you use through the Facebook app on your phone will not count. You have unlimited access to Facebook free-of-charge.

Although I had been aware of specific cases, I had not know of a source with more comprehensive information. This data has now become available through Allot Communications (Summary on GigaOM).

Some things that I find interesting;

This is now available even in the US. AT&T even has a program where the content providers themselves pay the consumers’ data bills.
49% of carriers worldwide surveyed by Allot Communications have this kind of data exemption plan.
Of these, 65% exempt Facebook.
This increases ARPU (average revenue per user) for carriers and also reduced the churn rate, making it very attractive for carriers.

Some of my thoughts;

If you were an e-commerce retailer, you would probably want to have your app included in the data exemption list. You might even be willing to pay for consumer’s data if the online purchases made up for it. In fact, there might be many e-commerce retailers who want to do this.
As a carrier, you could choose to partner with only one e-commerce retailer if these retailers were poorly differentiated anyway. By doing this, you might get very favorable terms. You could even pre-install that retailers app on the smartphones that you sell.

My thinking is that carriers could profit quite a lot from this scheme.

Microsoft Now Officially Weeding Out Chromebooks with Price Assault

I’ve been writing quite a lot on this blog about Chromebooks. This is because it is a case study into what qualifies for a disruptive innovation and what does not. This story also tells us that corporate history is one yardstick we can use to determine whether or not the incumbent will address the threat of disruption head-on, or whether they will flee up-market.

My position which dates back to January 2013, is that Chromebooks will follow the fate of Netbooks. In fact, since the sales of Chromebooks are significantly lower than peak Netbooks, it will likely end as a dud that only the tech industry showed any interest about.

The thinking was very simple, and all I did was say that;

This time, if Microsoft decides to fight back, they would start providing Windows 8 cheaply to low-spec models like the Acer. They would also add free SkyDrive capacity. It is also likely that they would include free Office 365 to compete with Google Docs.

Microsoft has now officially started to do this.

Microsoft COO, Kevin Turner is cited as saying;

“We are going to participate at the low-end. We’ve got a great value proposition against Chromebooks, we are not ceding the market to anyone.”

NewImage

Microsoft is not invincible and there is no guarantee that fighting Chromebooks head-on will be net positive for Microsoft. It is possible that the low-end Windows devices will cannibalize Windows revenue without generating new revenue from Office 365, etc. What we do know however is that Microsoft’s corporate culture has repeatedly addressed low-end disruption head-on. It will undercut low-end disruptors if they ever gain a foothold.

This is simply a case of Microsoft doing what it has always done once again.

The Stupidity of Bashing the Failing

A recent article in The Economist was so stupid that I couldn’t resist writing about it.

Japanese electronics firms, Eclipsed by Apple

These kind of stupid articles are nothing new. As one would expect, the self-critical Japanese have been writing them years ago. I’ve criticized the logic that these articles use in this blog (1, 2 ).

It’s similarly easy to find the flaws in the logic that The Economist used;

In the article, the author assumes that Japan’s culture of lifetime employment and the associated labor rules are at least partially to blame for Japan’s problems. In fact, this is the only hard reason that is cited. If this was true, then we should see a correlation between a countries willingness to fire workers, and the ability of that country’s corporations to bounce back from hard times. As a prime example of a country that doesn’t think twice about firing workers, we can use the US. Also, as another example of a country where firing workers is difficult, we could use Germany. Although we don’t have nearly enough data to make a statistical argument, I sense that we would have a hard time validating this correlation.
Another problem with blaming it on Japanese corporate culture is that if you look back in history, back into the booming years (which was not always smooth riding, but instead had its fair share of bumps), the aforementioned culture was even more intense. In fact, Japan’s lifetime employment was once envied by at least some US authors. Unless you can explain how Japan’s lifetime employment actually seemed advantageous during the two oil-shocks, you aren’t really in a position to blame the current problems on it. Below I refer to a random article that I found on the web, but I recall that these discussions were abundant in 1970-80.
> Coming at the peak of Japan’s industrial ascendancy, Abegglen produced his insider’s guide to competing against the Japanese challenge, Kaisha: The Japanese Corporation (Abegglen and Stalk, 1985). He repeated the argument that comparative advantages lay in the Japanese firm’s high levels of social integration around lifetime employment.

It’s easy to present theories why Japan maybe faltering. It’s actually just as easy to give a reason why Japan was booming in the 1970-80s. Being able to present a reason for either does not mean that you have a good theory, or that you have any real intelligence. It just means that you can look at two things that may or may not have any meaningful association, and conjure up some logic to say that one caused the other. It means that you have a bit of imagination. Even more embarrassingly, it shows that you’re not thinking with your head, but you are simply following the crowd.

To give a concrete theory that can be consistently used for a least a few decades (and will not look ridiculous after twenty years), it has to be applicable to a span of at least half a century. For a theory on Japan, it has to explain both the boom years and the current stagnation. It has to be a theory that can cause both the good and the bad, depending on circumstances.

For example, what you really want is a theory that can explain why the US consumer electronics industry, which invented the TV for example, is now very weak. Much, much weaker than the state that Japan finds itself in. Or you could try to explain why the company that invented the cell phone (Motorola) has been sold off to a China firm. Or you could try to explain what happened to PC makers in the US. Or you could try to explain what happened to the U.K. automobile industry. If you can come up with such a theory, then and only then will you be able to give some good advice to Japan. Then and only then will be able to predict what will happen to Samsung and the Chinese in the next 50 years.

It’s a bit like trying to understand why a split-fingered fast ball has a different trajectory from a fast ball. If you were only looking immediately after the pitcher released the ball, you would think that a split-fingered fast ball files straight. On the other hand, if you were only looking near the home plate, you would think that a split flies down. Neither it the truth on its own. To understand a single pitch that can change its trajectory so dramatically, you have to take a hard look at how the ball is spinning and how that interacts with the atmosphere. Instead of simply looking at the trajectory, it’s about time that business analysts started looking at spin and aerodynamics.

That is not what the article on The Economist was. It was just a bit of imagination.

Samsung Earnings 2Q14

Samsung’s earnings are in, and they were not very good (Bloomberg: note the original title in the URL slug. The title and tone of this article were revised from the pessimism in the original publication to a much more optimistic tone, which shows how worthless financial reporting has become).

Given these poor results, the blogosphere is awash with analysts telling us that they saw this coming. This is hardly something to brag about because it was so plainly obvious.

It’s also very easy to blame this on what Samsung does not possess; that is software and services. This is equally trivial to do. Giving a sound explanation of why Samsung is now in trouble, does not suggest that you have a clue about what is happening. Anybody can do that. It’s like saying the reason the New York Yankees are pretty weak right now is because their batters aren’t hitting the ball well.

To suggest that you really understand what is going on, you need to provide a coherent explanation of why Samsung was very strong a few years ago, and why it is now starting to fail. This explanation must consider that Samsung itself is mostly doing exactly the same things that there were before. Hence this explanation should not focus on factors that are internal to Samsung, but are external.

Hence the following explanations fail to suggest that the analyst who made them has a clue;

Marketing as a reason for Samsung’s success: Strong marketing is no doubt a reason for Samsung’s ascent to dominance. However Samsung has not relaxed its marketing focus. Unless we have a good explanation of why Samsung’s marketing is no longer effective (external factors), it doesn’t explain the situation.
Software & Services: Samsung is weak in software and services, but it has always been like this. In fact, Samsung knows this and has invested heavily into making itself better in software & services. The lack of strength in software & services does not explain Samsung’s problems because Samsung rose to dominance without them in the first place. Instead, we need an explanation of why software & services matter more than they used to or why Samsung’s efforts have become meaningless.
Cheap Chinese vendors: There have always been cheap Chinese vendors. Hence their presence itself does not explain anything. What has changed is that the Chinese vendors are now capable of creating products that rival Samsung’s in both quality and price at the lower-end of the market. What we need to understand is why the Chinese can now do this whereas they couldn’t do so before.

Clayton Christensen’s theories explain all of these. That’s why I lean on them.

In this context, what is interesting in Samsung’s report is actually the following;

Profit at Samsung’s chip unit, which supplies its own devices and also rivals such as Apple, nearly doubled to 2.1 trillion won on sales of 9.5 trillion won, according to the Bloomberg News analyst survey.

According the “the law of conservation of attractive profits”, as smartphone production becomes more modular allowing new entrants into the market, the attractive profits will shift to somewhere else in the value chain. Although not certain at this point, it is likely that component suppliers will be one of the stages where the attractive profits will accumulate. If so, Samsung’s chip unit may profit (although there is intense competition here as well).

It will be interesting to see how the component industry (Samsung’s chip business, MediaTek, etc.) does in the next few years.

Android OEMs and The Law Of Conservation Of Attractive Profits

A couple of days ago, I wrote a comment on an article on the Tech.pinions website.

The article (by Jan Dawson) was discussing how Samsung came to dominate the Android OEM market, but how it is now struggling with competition on the low-end and is also having difficulty in differentiating itself.

The comment that I wrote;

It’s very interesting that you call Samsung “exceptional”. This is because, at least in my interpretation, the trajectory of Samsung’s accent and decline is precisely what Clayton Christensen’s theories would predict.

I’ve been thinking more about what I wrote, and I think that this is such an important issue that I should put it up as a blog post. Here, I will copy my original comment and add a bit more to it.

The rise and fall of Samsung as a smartphone OEM

Jan Dawson lists the keys to Samsung’s success as the following;

“On the marketing side, Samsung has vastly outspent all other Android smartphone manufacturers and become the default option for people in mature markets looking to buy a mid to high end smartphone.”
“Its vertical integration has allowed it to compete very efficiently and effectively with screen and other component technology.”

Jan Dawson also outlines Samsung’s current problems;

Overall smartphone growth is slowing, putting pressure on Samsung’s other device categories to provide stronger growth

Samsung’s dominant position in Android is being assailed at the low end and in the mid market by a variety of competitors, many of them from China

Google is reining in Android and looking to reassert its own position and services in the smartphone market, putting pressure on Samsung and others to tone down their customizations. New flavors of Android for wearables, the car and TVs will provide even less room for customization

People are at any rate apparently tiring of Samsung’s customizations of Android and starting to look more seriously at smartphones which provide a stock Android experience or at least something more like it

Samsung’s marketing spend is starting to experience the law of diminishing returns, where each dollar of spending no longer conveys the advantage it once did. It has effectively saturated the market and can no longer derive the advantages it once did from its far superior ad spend.

I completely agree with Jan Dawson’s assessment of why Samsung was successful, and Samsung’s current predicament.

The problem is, how did Samsung transition so quickly from “huge success” to “quite problematic”.

Jan Dawson doesn’t go into explaining the transition in depth. That is what my comment tries to do by applying Christensen’s theories.

How the environment changed from favorable to hostile for Samsung

Christensen’s theories are build on the premise that continued innovation (sustaining innovation) will ultimately open-up the possibility of low-end disruption, and that it can be very difficult for some companies in some markets to counter-attack the disruptor.

Hence to understand what happened to Samsung, we should analyze how technical advances changed the competitive landscape, and allowed low-end disruptors to enter the market. That is what I tried to do in the comment;

When the product is not good enough, the attractive profits flow to the integrator. This was the situation at the beginning. Samsung’s ability to integrate the hardware stack and to also put a UI (that was attractive in the sense that it more closely imitated iPhone) on top was the reason they had the best Android product.

As technology improved, customized integration became less necessary. This caused modularity in the hardware stack. SoC vendors like MediaTek are prime examples of the hardware becoming more modular. Also, as Android got its act together and became less ugly, Samsung’s ability to put their UI on top became less important and even downright annoying. Hence the software vendor (Google) increased its power. In fact, integration within the software stack increased. In total, the Android value chain became modularized and Samsung’s strength as an integrator waned.

Samsung tried to buck this trend by creating products that we much better than those assembled from modular parts (which is the same as Apple’s strategy). Hence they designed their own CPU and added features to their software. Unfortunately, both were unsuccessful. Neither created value that appealed to their customers.

The first item explains why Samsung rose to dominance. Samsung is very vertically integrated in hardware. It has top-level semiconductor technology, display technology, wireless technology, etc. Importantly, because Apple had to rely on Samsung for key components, Samsung learned of Apple’s iPhone plans many months before their competitors. None of their competitors had a similar advantage. This allowed Samsung to rapidly produce the best Android smartphone hardware

One thing I want to add that is rarely mentioned is that Samsung’s TouchWiz UI was well received during these early years. Before Android 4.0, the Android UI was pretty bad (Android 4.0 was a huge overhaul of the UI). Samsung’s TouchWiz imitated the iPhone UI much more closely than stock Android, and this was no doubt one of the reasons why Samsung was so successful. Hence in this context, Samsung’s ability to create a good UI skin was also a key factor in its success. As far as I can tell, yearning for a stock Andorid experience is post Android 4.0. Until then, stock Android was not “good enough”.

Going on to the second item, we start to see how technical progress changed the environment. Christensen has described how markets eventually favor modularity over integration after the products become “good enough”. As component technologies improve, it becomes less important to fine-tune the components to obtain the necessary performance. Customers are now satisfied by products that are simply assembled from “off-the-shelf” components (from SoC vendors like MediaTek for example). In many cases, even the assembly is outsourced to China. Because fine-tuning is less important, this allows low-end entrants without extensive hardware expertise to enter the market. Because the low-end entrants do not need much hardware expertise, their business models are often very different from Samsung’s. For example, Lenovo is a low-cost assembler of hardware, an operation that doesn’t require much R&D spending. Cherry Mobile, a fast growing smartphone brand in the Philippines is actually a carrier, not a hardware maker. Xiaomi, a fast growing fabless smartphone maker in China that sells mid-range phones with razor-thin margins, earns profit not through hardware sales but through service sales and reduced costs on marketing.

It is also important to note that many of the new entrants mainly have strengths in their local markets. Cherry Mobile (Philippines), Xiaomi (China), Lenovo (China), Micromax (India), Wiko (France), BQ (Spain) are some of the examples. Being local companies, they have some marketing advantages over Samsung and can better tailor their products to local preferences.

To reiterate, technical progress has allowed low-end entrants with a very different low-cost business model, to enter the smartphone market. Samsung’s integration and expertise in hardware is no longer a competitive advantage. In fact, it could even become a liability because it could make it difficult for Samsung to directly address these low-end entrants.

Technical progress has changed the initially favorable environment for Samsung into a hostile one.

Google’s increased power over OEMs

This is explained by “the law of conservation of attractive profits”, which I have described in a separate post.

It also explains why Google now has the power to reign-in Android. The negotiation power of the integrators has declined and has shifted to the OS and service vendor. Google did not have this power until the hardware stack became modular.

The law of conservation of attractive profits allows Google to have stronger influence over Samsung. However, as I described in the previous post, I tend to think that this is temporary and that the attractive profits will transition back to the OEMs who have alternative business models.

Looking into the future

One of the more interesting features of the recently announced Android “L” is the new ART runtime. This looks like it will significantly improve Android performance on low-end hardware. This will accelerate the shift in power away from Samsung and towards the low-end entrants. Combine this with the Android One reference platform, and we will likely see almost all value in low-end Android hardware sucked out. Samsung will have a very hard time competing in this market, and since their competitors are now asymmetric, it’s very hard to see how they can launch a strong counter attack. However, since most of the entrants are local, the spread of low-end entrants might be a gradual process.

On the high end, especially in markets where the cost of the smartphone is subsidized by the carrier, Samsung will continue to be the dominant Android OEM. Other Android OEMs simply cannot match Samsung in marketing and product features. Whether that is enough given the strength of iPhone is yet to be seen.

Importantly, Google’s strategy is providing absolutely zero incentive and zero profits for OEMs to innovate in hardware. With this market structure, it’s difficult to see how the low-end entrants could evolve to the point where they can overtake Samsung in the high-end, even Xiaomi or Lenovo. I don’t see this ever happening in the foreseeable future.

Actually, this could make Apple more dominant in the high-end, and Google probably won’t even care.

Statistical Validation of Disruption Theory

There has been a bit of discussion on the web about the validity of Clayton Christensen’s Disruption theory. I hope this article by Thomas Thurston will put it all to rest; “Christensen Vs. Lepore: A Matter Of Fact”.

Most people don’t know this, but it turns out Disruption Theory is the foundation of the most accurate, thoroughly vetted, quantitative prediction models of new business survival or failure in the world today.

…

I did my best to reduce his theory to falsifiable yes/no logic using published research. Even so, in the first round these relatively crude rules based on Disruption Theory blindly predicted if new businesses would survive or fail with 94 percent accuracy and over 99 percent statistical confidence. Holy crap.

So statistically, disruption theory is pretty good a predictions.

How often does it get it wrong?

A lot of people point to examples of when Disruption Theory, or Christensen, was wrong. It was wrong about the iPhone. Tesla. Ralph Lauren. In fact, it’s been wrong over 7,500 times by my count (remember it has a 33 percent error rate when predicting winners). Keep in mind, however, it’s 66 percent right while everything else is stuck at 25 percent. Improvement, not perfection, is the standard.

Well, it doesn’t get it right 100% of the time. Does that mean the theory isn’t valid? Not at all.

Many bloggers dismissed or attempted to modify Disruption Theory because it got Apple wrong. These people don’t understand statistics or don’t understand how to use statistics to validate or invalidate an argument. I could list them here, but I won’t.

The method used here is very standard. For example, every new drug that comes to the market is tested for effectiveness using the same statistical methods. Drugs sometimes work, but often they don’t. All they have to do is work a bit better, a bit more often. If we rejected every drug that ever failed to work for certain patients, there would be no drugs.

I especially like Thomas’ closing sentence. It’s the standard way of statistically testing which theory is correct, which Thomas uses to test Lepore’s theory against Clay’s. Anybody who doesn’t fully get it shouldn’t be talking about how theories are validated.

Lepore could be right about Disruption Theory, but the odds are literally over 500,000 times greater that, as a matter of fact, she’s just plain wrong.

P.S.

Although I am appalled that a large number of people who discussed Disruption Theory on the web didn’t seem to understand the basic principles of statistical testing, I understand where they came from.

Statistics simply isn’t taught enough at schools. Statistics, in my view, is one of the most important branches of mathematics and is relevant even for people who won’t touch maths ever in their professional careers. We have to understand statistics so that we, in democratic nations, can correctly assess the accuracy of claims made by politicians, and so much more.

This is a real shame.

Google Self-Driving Cars and The Car Industry

Reuters article; “Google, Detroit diverge on road map for self-driving cars”

Not too much of a surprise for anybody who has worked in a regulated industry.

In 2012, a small team of Google Inc engineers and business staffers met with several of the world’s largest car makers, to discuss partnerships to build self-driving cars.

In one meeting, both sides were enthusiastic about the futuristic technology, yet it soon became clear that they would not be working together. The Internet search company and the automaker disagreed on almost every point, from car capabilities and time needed to get it to market to extent of collaboration.

I think that this part sums up the situation well;

“There was a certain amount of arrogance on the Google side, in the sense of ‘We know what we’re doing, you just help us,’” said a second person, representing a major car maker, who was involved in discussions with Google.

“We’d say, ‘Well you don’t really know that much. And we’re not going to put our name on a project like that because if something goes wrong, we have a lot more to lose.’”

I seriously doubt that Google has the patience and the willingness to work with others that is required to pull this off.

Japan’s Largest University Switching to Microsoft Office 365 from Google Apps (Docs)

The largest university in Japan, Nihon University will provide “Office 365 Education” for all of its 100,000 students according to the Microsoft Japan website.

I’m still in the process of researching the details, but some things that have been mentioned that I find very interesting;

Nihon University had been using “Google Apps Education Edition” since April, 2007.
Reason 1: Faculty staff used Google Apps but student uptake was not good. Students preferred to use their own free mail accounts.
Reason 2: Unfamiliarity with Google Apps was a reason for slow uptake. By providing the software that everybody is familiar with (Office), Nihon Univ. hopes that students will also use scheduling and address book features.
Reason 3: Students were pirating MS-Office install disks. Office 365 will make that a non-issue. Nihon Univ. chose the A3 plan with Office 365 ProPlus, which means that faculty and students can install Office on 5 PCs per user.
Annual price per faculty is 410 JPY, per student 230 JPY. This ends up being cheaper then when they were using “Google Apps Education Edition” because even when they were using Google, they still needed to buy significant installations of MS Office.

Although we still need more examples to see whether this is a trend or not, I sense strong beginnings.

Cloud is getting cheap

The most powerful allure of Google Apps is the price. For general consumers and for education, the price is free. This was possible because Google had a robust advertising model. By injecting ads in the web user interfaces, Google could justify the cost of providing the service for free.

Historically, Google was uniquely positioned to provide an office suite for free. Other companies could not do this profitably.

However, as technology improved and the hardware required for cloud services dropped in price, it became feasible for companies without a robust advertising model to provide free or very cheap cloud services. This can be witnessed in the recent announcement at Apple’s WWDC 2014. Apple announced that they would be providing CloudKit effectively for free.

We are now at the point that we don’t even need advertising anymore. It has become feasible to provide free or very cheap cloud office suites, even without advertising. Hence anybody can do it. Google no longer has a unique advantage in providing services for free.

Google Apps never became “good enough”

With the cost advantage of Google Apps eroding, the argument for choosing either Google Apps or Office 365 now rests on the benefits that each platform provides. This is something that Google Apps was never designed for.

Since its inception, Google Apps was designed as a simplified version of MS Office that justified its existence by being much cheaper. Although it had some unique collaboration features, it never evolved to become better than MS Office. It was always obvious that if it lost its cost advantage, it would lose out against MS Office.

Looking at the reasons why Office 365 was chosen over Google Apps, it’s very apparent that Office was still an application that both faculty and students needed to use from time to time. Google Apps had never become “good enough” on its own.

Microsoft is changing

Since the costs of providing cloud services had decreased, the only roadblock for Microsoft going aggressive with Office 365 was the possibility of cannibalization. Office 365 could potentially cannibalize sales of their standalone office suite.

A few thing have happened that might have changed their minds.

Adobe has been very successful with their Adobe Creative Cloud.
Microsoft’s new CEO is a cloud guy.

What are the trends?

These are the trends that I think we are beginning to see.

Google’s strength in advertising will no longer be sufficient to maintain an advantage (based on cost) in the cloud. Cloud costs have gone so low that advertising is no longer necessary for a free/low-cost service. Subscription services are proving to be a good business model.
With the price issue becoming less of a concern, competition in the cloud will focus more on features and usability. In established markets, one feature that will continue to be extremely important is compatibility with de-facto standards (both in file-formats and user interface).
As the focus shifts to features and usability, native applications will maintain their advantage against web apps.