Future of Phones.. Good Enough?

As an investor, I believe we will see a massive new wave of companies redesigning retail. Five years ago I had a camera, an iPod, a PDA, GPS, phone, … today I have one device. What will the bundling (or unbundling) of retail look like? What are the problems to be solved?

16 Sept 2012

Quote of the week

It’s not clear that NFC is the solution to any current problem…

Apple Senior VP Marketing – Phil Schiller

A few months ago I was in Hong Kong speaking with institutional investors at CLSA’s annual event. One of my more memorable meetings was with James, a chief investment officer with a top 5 investment bank. The heart of the discussion was on the future of telecom. Although I’m not a telecom expert, James was interested in finding “the next killer app” in mobile. Was NFC it?

His investment thesis was that phones are starting to become commodities: screens, LTE connectivity, cameras, battery life, applications, …etc are all reaching a point of good enough. His time with me was spent drilling down into payments and NFC in order to see if I had any new data which would alter his view.  I did not….

What will happen in a world where handset hardware is no longer the basis for competition?  The same thing which occurs to any manufacturing area where a “good” becomes a “commodity”: margins compress for the commodity and migrate to the new area which is basis for differentiation/competition. Yesterday I outlined the implications, and investment opportunities, for the mobile operators.

This week we saw the launch of the iPhone 5.. better, brighter, bigger, lighter, clearer, faster, lasts longer, crisper, sturdier, takes better pictures, more tightly integrated to applications that Apple controls, …etc. A great new product.  An Evolution… not a revolution.  What Apple understands better than almost any consumer product company is: consumer experience matters.  While some handsets already exceed those of  Apple’s iPhone in feature/function (Samsung’s Galaxy S III)…  none can match it on consumer experience. Experience is where Apple is focusing its efforts, and the major shift in iPhone capabilities is NOT in hardware features.. but on orchestrating value in ways it can control.

Apple takes a Clayton Christensen approach to the iPhone: what problems does a customer have, and how do I solve them? For example, I hate typing in my name and address on a little mobile browser to order a good from lets say Gap.com.  Apple’s passbook will resolve this by allowing Gap to integrate to passbook to pull all of the “iTune’s account” information over .. so I don’t have to fill this out anymore.   Apple is moving to solve real consumer problems…  It is looking to orchestrate value delivery.. moving the “hub” of coordination from the phone to iCloud.

This is what I refer to as the Stage 4 Value Shift (see April Blog). Theoretically, an open innovation model (ex Google/Android, Java/Oracle, …) should be able to quickly surpass Apple, as 100s of small companies invest larger amounts (cumulatively) in expanding capabilities of a “platform” (see platform leadership). However, Apple has learned its lessons from its Mac days and has defined competition along the lines of “consumer experience”. In this model, it does NOT CARE about interoperability or standards… rather Apple is maniacally focused on delivering value to consumers with usability, reliability, intuitiveness, …  being core measures.  Apple’s brilliance is multi-faceted, but by defining product focus along the lines of consumer experience, the iPhone’s closed model of innovation can not only effectively compete, but win easily against open systems. In other words, while open systems compete more effectively in a feature/function war.. they loose in the qualitative measures of “experience”.

Apple will obviously monitor the environment for effective new features, to ensure that the core product hardware remains competitive. For example, the real world transaction data for NFC based payments is a complete joke. There are no phones, there are few terminals, and there is no consumer or merchant value proposition. Sure there are exceptions like Japan, but only closed systems with a monopoly leader have proven the ability to push the solution out.

Apple does see a need to improve device-device communication, as well as shrink the hardware footprint. With these drivers, and given the prototypes in market, I fully expect Apple to redefine phone hardware architecture with a new integrated chipset that would encompass functionality of: controller, radios (wi-fi, BT, 14443, …etc), secure element that would also enable the SIM to be virtualized and placed within the SE. If this is indeed Apple’s direction, it will not be a new basis for hardware competition on feature/function, but rather: battery life, footprint and control (ex. virtualized SIM).

Other players also have unique strategies and assets. For example, Google’s strategy: orchestrate value based on consumer data. In assessing investments I look for one key answer: what problems are platforms trying to solve and in what marketplace?

All about Commerce… and Entertainment

My major issue with Apple’s strategy is the degree to which other entities can participate. I see mobile phone revenue streams in 2 major buckets: Commerce and Entertainment.  Entertainment is not a focus for me.. Commerce is. Businesses operating within the retail sector are undergoing fundamental transformation. For 1000s of years, local merchants survived based upon distribution and availability. Today they are left trying to sell a commodity product at a higher price to consumers in a marketplace with near perfect transparency.

What is the roll of any intermediary in commerce? Not just in the selling, and purchasing, but in marketing, product selection, distribution, service, support, … What does the new face of retail look like? This is the focus of Amazon… they are the leader here from a “virtual commerce” (e and m) perspective.

As an investor, I believe we will see a massive new wave of companies redesigning retail. Five years ago I had a camera, an iPod, a PDA, GPS, phone, … today I have one device.  What will the bundling (or unbundling) of retail look like? What are the problems to be solved? In the past 15 years mobile has grown up along side of commerce, operating primarily as a replacement to fixed line and then migrating to a replacement for online. We will start to see phones leap into commerce in new ways.. but my firm position is that this leap does not start with payment (the last phase of a commerce) but with marketing (the first phase). Why? Because marketing and retail are fundamentally broken, and Payments is NOT.

It is in this context that I laugh at NFC solutions. My favorite quote on this topic was from head of strategy of top 5 retailer

“Mobile Operators know how to run dumb pipes, not create business platforms for marketing… their current wallet initiatives are akin to a toll bridge, NFC is their toll booth where they stop me before reaching my customer..  to cross their NFC bridge I have to wait in line and when I arrive at the gate they don’t want $0.50 toll.. they want 3.5% of what I’m carrying in my truck, and a copy of the shipping manifest (customers’ names). This model doesn’t work for me. “

Commerce will find another path… one of least resistance … of better “experiences”. This is what Apple is enabling in Passbook, and why Amazon is succeeding in commerce. NFC is just a radio… one who’s standards are largely controlled by banks, mobile operators and card networks. Why would retailers want to participate here at all?  We should not act to enrich the complexity of payment networks, or wireless ones, but rather form new networks.

Sorry for the typos.. and re-hash of past blogs.. hope it was useful.

Carriers as dumb pipes?

Given Apple’s tremendous earnings yesterday, 80% growth in iPhone shipments (30M), 150% year-over-year growth in iPad shipments with margins improving to 47%…. what does the future hold for carriers? If consumers go to the Apple store to select product and network is just an afterthought? Retailers also loose when manufactures can create both an effective BRAND and EXPERIENCE (see related USA Today article and Forbes).

25 April 2012

I just bought a brand new Galaxy Nexus on Google’s new play store today (https://play.google.com/store), very excited to have an unlocked GSM phone that I can take with me around the world. Better yet, I can now take advantage of Google wallet and many new NFC based applications..  independent of any carrier (… although the Sprint people are A+).
Given Apple’s tremendous earnings yesterday: 80% growth in iPhone shipments (30M), 150% year-over-year growth in iPad shipments with margins improving to 47%…. what does the future hold for carriers? If consumers go to the Apple store to select THE product will The Network be an afterthought? Its not just the MNOs who are on the short end of the stick, Retailers also loose when manufactures like Apple create an effective BRAND, PRODUCT and EXPERIENCE (see related USA Today article and Forbes).
How are the carriers responding? What are they doing to deliver new value or help the industries impacted by this new dynamic? They have gotten together to create an environment where they completely control everything: NFC (in the US it is a consortium called ISIS).  I was one of the first to break news of this consortium back in 2009, with some strong recommendations on their strategy (see Ecosystem or Desert).  If you were a retailer, or small company with limited resources, where would you place your bets? With Apple..? or a consortium of mobile operators that have been working for 3 yrs trying to get a pilot working across 12 different suppliers.

This week, I was struck by how similar the carriers “walled garden” NFC strategy is to previous attempts to create a “Walled Garden” . Why are the MNOs recycling the same control strategy? Remember Einstein said “the definition of insanity is doing the same thing over and over again, but expecting different results”.  As background, VZ (and most MNOs) love the “walled garden” strategy.

Version 1(2004-Present). BREW platform from Qualcomm (dumb phones).

Version 2 Handset capabilities

  1. Verizon invested over $300M in GPS “platform”, an investment they planned to recover by charging for Apps that wanted to use GPS. RIM was the first to realize that it could not deliver consumer features at odds with what VZ would authorize.
  2. Firethorn was the first payment related application that VZ promoted. Objective was to limit all consumers to Firethorn as the only approved “signed application” where consumers could check their bank balance. Banks were each asked for $1M to allow for their customers to check their balances on this MNO controlled application.. yeah.. great idea (2007)
  3. Search. $600M exclusive deal w/ MSFT in 2009. Unfortunately for MSFT, Android was not included agreement and then VZ make “Droid” THE key marketing theme.
  4. I could go on.. but

Version 3 NFC

  1. Control SE (http://tomnoyes.wordpress.com/2011/02/03/isis-platform-ecosystem-or-desert/)
  2. ISIS. Consensus is that the carriers will keep plugging along at this for 10 years..  however without talent, retailers and handsets I don’t see how they can sustain investment.
  3. Create a new BREW.. handset platform that leverages NFC and secure customer data.. payment (ISIS) is just one of the applications. Note that most carriers are in midst of issuing RFPs for SE management (my vote is for Sequent here). The objective of this effort is to create a “secure platform” where applications can leverage customer data (for a fee).

Would you want to “play” in a walled garden? The owner gets to make the rules and take the rug out from under your feet (ie MSFT $600M). Where the star (ie Apple) is able to negotiate special treatment or go over the top without you ever being aware? No way.. you can’t run a business like this. I wouldn’t even want to play..

Carriers must think about value creation before they can think about control. Apple earns its margin from brand and experience… they are not forcing people into their store. For example, the Samsung Galaxy Nexus is an unbelievable phone… easily on par with the iPhone.. But the carriers won’t let it in the market unless Google give them the keys to the SE.  It’s just crazy…My 11 yr old son can guess what happens next.. Google starts selling the phone directly (which I bought today). As most readers know, the US handset market is a very strange place (handset subsidies and post paid plans). The rest of the world buys their handsets and selects the carriers based upon cost/coverage. What if Google and Apple were to subsidize handsets through marketing, as opposed to anticipated spend? If telephone calls and data were routed through wi-fi whenever available? What do carriers have left?

Every point of “friction” which carriers create.. FURTHER ERODES their future profitability as this friction improves the profitability and market opportunities for companies going above, around and under them. Carrier business culture and experience all surrounds the walled garden “control” approach. This control approach works well for Apple as it has developed an integrated value proposition.. It does not work for the carriers that offer connectivity. To expand beyond connectivity carriers must create new services.. the must become orchestrators of value.. not controllers of handsets. In other words they need to shift from a “permission/transaction/payment” paradigm to  one of discovery->need->->fulfillment. (see my previous blog).Attention US Mobile operators… today your trajectory is headed toward dumb pipes.  You cannot deliver value through control.. no one trusts you.. and you can’t sustain investments to compete against Google, Apple, Facebook, …

What should you do? Where is the revenue opportunity? It is in value orchestration. You have direct consumer relationships… leverage them for marketing, authentication, personalization, awareness. The good news is that Hardware will peak and reach a “good enough” stage. If hardware is a commodity, then brands will begin to deteriorate.. and value orchestration will shift further from the handset node into the Cloud. If any operator agrees with this.. then ask why on earth are you locking all of this customer data inside a phone (NFC) where it cannot be used or sync’d with the cloud.

I will get off my soap box now.

BTW.. AT&T I fully appreciate that you can disable my new Nexus.. please dont make me go to an MNVO.. just another point of friction.