Digital Hub 2.0

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My question last week – How Much Will CarPlay Cost – was not an idle one. Most readers – and I include myself in this group – presume that CarPlay is, as I wrote, “a strategy that is based more on propping up the iPhone than on building a separate revenue stream.”

Another way of putting it is that Apple is constructing a world with accessories that connect with and are powered by their flagship device. Call it Digital Hub 2.0.

Digital Hub 1.0

The articulation of the original “Digital Hub” strategy remains one of my favorite Steve Jobs keynotes. Jobs began by recounting the conventional wisdom about the PC – boring and dead:

This is what everybody else is telling us: that our PC is waning, if not the hole being dug. One of the smartest journalists in our business, this guy named Walt Mossberg, somebody I admire because he cares about the same things we do. And even Walt, a few weeks ago said, “The PC, which has carried the digital revolution for the last 24 years, has matured into something boring.” That hurt, but Walt’s really smart, and we listen to him very carefully. Mike Capellas, who runs Compaq, “We don’t think of it in terms of the PC business anymore.” Hm. And Jeff Weitzen, who runs Gateway, “We’re clearly migrating away from the PC as the centerpiece.”

An animated Jobs adamantly disagreed:

We are living in a new digital lifestyle with an explosion of digital devices. It’s huge. And we believe the PC, or more importantly the Mac, can become the digital hub of our new emerging digital lifestyle, with the ability to add tremendous value to these other digital devices.

Jobs’ prime example was the effect iMovie had on your camcorder, making it worth 10x as much:

And we saw that the benefit here was a combination of a bunch of things. It was hardware, the computer and other hardware, the operating system, the application, the Internet, and marketing to create this solution…So we thought this was very important and it took all these components and we realized that Apple is uniquely suited to do this because we’re the last company in this business that has all these components under one roof. We think it’s a unique strength. And we discovered this with iMovie 2, that it could make a digital device called the camcorder worth 10x as much. It’s 10x more valuable to you.

The parallels to today should be obvious. The consensus from this year’s Mobile World Congress was that smartphones are boring now, innovation has peaked, even as Apple remains the sole vendor in control of the entire stack. So why not Digital Hub 2.0?

Whither iCloud

It was Steve Jobs himself who, in his final keynote, declared that the Digital Hub strategy had run its course:

About ten years ago, we had one of our most important insights. And that was that the PC was going to become the digital hub for your digital life…but it’s broken down in the last few years. Why? Well, because the devices have changed…

So, we got a great solution for this problem. And we think this solution is our next big insight. Which is we’re going to demote the PC and the Mac to just be a device, just like an iPhone, an iPad, or an iPod Touch, and we’re going to move the digital hub, the center of your digital life into the cloud, because all these new devices have communications built into them, they can all talk to the cloud whenever they want…we call it iCloud.

Apple’s shortcomings with cloud services are well-documented (even Jobs cracked a joke about MobileMe while introducing iCloud), and iCloud hasn’t improved things much. And, frankly, no wonder:

  • Apple, which prides itself on perfection and big releases, isn’t well-suited culturally to building cloud services that depend on iteration and failing gracefully.
  • Apple’s business model is about selling devices, not monetizing cloud services
  • Apple won’t lose customers if their cloud services are subpar (the flipside of the previous point)

In other words, were iCloud truly the center of Apple’s strategy going forward, they would be at a disadvantage. I think, though, that while iCloud did indeed supersede the old Digital Hub strategy, it’s not the end-all-be-all.

The Three Types of Services

“Services” is a word that is well on its way to being meaningless; you might as well ask what isn’t a service. I think it makes more sense to consider three clear categories:

  1. Device-agnostic services – These services are native to the web, and work the same everywhere. Think email, calendar, search, etc. In the consumer market, these are primarily funded through ads, and while iCloud provides things like Mail and Calendars, it’s not a differentiator, and hasn’t been for many years now.

  2. Content services – Content was at the heart of the old Digital Hub strategy: things like movies, videos, music, etc. Apple has long been exceptionally strong here, and iCloud is actually a continuation of that strength. iTunes Match, for example, is a great service, and Photo Stream, for all its limitations, works well, particularly when it comes to private sharing. The cloud is clearly superior to the old sync model at the heart of Digital Hub 1.0.

  3. Device services – This is new, and it’s a place where Apple has a significant opportunity. Device services are physical devices that are improved by means of your primary device. Think Nest, the Nike Fuel Band, or Sonos. In fact, you’ve almost certainly encountered the other name for device services: the “Internet of Things.”

A computing company that manages the entire stack around their device almost certainly has an advantage in this new services frontier.

Digital Hub 2.0

Think again about the CarPlay announcement. Your iPhone plugs into the car, and projects a control surface onto the dash; nothing is done by the car, it’s simply a conduit. It is, in fact, rather like an Apple TV with a car-specific UI. Again, a passive screen, effectively rendered an extension of the device in your hand. Were I to illustrate, it might look something like this:

The iPhone as a new kind of digital hub
The iPhone as a new kind of digital hub

What is your iPhone if not a digital hub? And, if that is true, might we be entering a new smartphone golden age?

iWatch

It’s true, of course, that the “Digital Hub” was the last golden age of the PC; one of the digital accessories for the PC was the iPod, which led the way to the iPhone and iPad, which relegated the PC to a specialized device. It wouldn’t surprise me if, over the course of the next decade, the alleged iWatch follows a similar path with regards to the iPhone.

Imagine a device that initially launches with limited functionality and is dependent on an iPhone (similar to the iPod, or the first iPhone). Perhaps it monitors fitness and health, and slowly, year-by-year, adds additional functionality. More importantly, assume that Moore’s Law continues, batteries make a leap forward, flexible displays improve, etc. Suddenly, instead of a phone that uses surrounding screens, like the iPhone does in the car and the living room, why might not our wrist project to a dumb screen (with a phone form-factor) in our pocket as well? Imagine all of our computing life, on our wrist, ready to project a context-appropriate UI to whichever screen is at hand. Moreover, by being with us, it’s a perfect wallet as well.

To be clear, this is certainly years off, but then again, the iPhone was decades off when NeXT was founded in 1985. The NeXTStep operating system is at the heart of iOS, and the iPhone wouldn’t be possible without it, or without OS X in 2001, iTunes and the iPod in 2001, or the App Store in 2008. Innovation is not the result of a moment in time, but of painstaking progress over years, even decades, and to my eyes, Apple is building something really interesting.

How much will CarPlay cost?

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Wes Miller has a useful summary of CarPlay:

In short, Apple hasn’t done a complete end around of the OEM – the automaker can still have their own UI for their own in-car functions, and then Apple’s distinct CarPlay UI (very familiar to anyone who has used iOS 7) is there when you’re “in CarPlay”, if you will. It seems to me that CarPlay can best be thought of as a remote display for your iPhone, designed to fit the display of your car’s entertainment system. Some have said that “CarPlay systems” are running QNX – perhaps some are. The head unit manufacturer doesn’t really appear to be important here. The main point of all of this is it appears the OEM doesn’t have to do massive work to make it functional, it really looks to primarily be integrating in the remote display functionality and the I/O to the phone.

In fact, the UI of the Ferrari as demonstrated doesn’t look to be that different from head units in previous versions of the FF (from what I can see). Also, if you watch the Apple employee towards the end, you can see her press the FF “app”, exiting out to the FF’s own user interface, which is distinctly different from the CarPlay UI. The CarPlay UI, in contrast, is remarkably consistent across the three examples shown so far. While the automakers all have their own unique touches, and controls for the rest of the vehicle, these distinct things that the phone is, frankly, better at, are done through the CarPlay UI.

It’s fascinating to think about who owns the power here. On one hand, geeks like myself may very well base a car purchasing decision on CarPlay; then again, it was geeks like myself who were willing to change carriers to get an iPhone. Many simply stayed with their carriers and waited for the iPhone to come to them.

The proportion between those two types was the basis of one of the more interesting bets in recent years; Apple originally wanted to launch the iPhone on Verizon, but Verizon refused to give Apple carte blanche over the user experience and phone appearance. AT&T née Cingular, on the other hand, gave over said control in exchange for exclusivity, and, ultimately, Apple (and AT&T) won the bet: enough users left Verizon that they had no choice but to acquiesce to Apple.

If that is the case with cars, then a CarPlay option is likely to be more expensive than a standard entertainment system, not less. Apple will push the idea that CarPlay will drive purchase intent, and that car makers ought to pay for the privilege.

On the other hand, the car industry is far more concentrated than even the carrier industry, with only about 10 players that really matter. Moreover, when it comes to a 10s of thousands of dollars purchase, just how much of a role can an Apple-designed entertainment system play? The Mercedes and Ferrari systems, with control-knob and resistive touch display control respectively, certainly suggest that Apple – who would certainly prefer a Volvo-like capacitative display – doesn’t have as much control over the interface as they would normally be accustomed to. This would suggest a much lower price, and a strategy that is based more on propping up the iPhone than on building a separate revenue stream.

Regardless, the primary takeaway remains, as always, that the product itself is not nearly sufficient to fully understand the strategic intent.

The Cost of Bitcoin

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Putting aside the particulars of Bitcoin, the potential it represents is absolutely a very big deal.

As I’ve written multiple times on Stratechery, the defining characteristic of anything digital is its zero marginal cost. Take apps for example:

What makes the software market so fascinating from an economic perspective is that the marginal cost of software is $0. After all, software is simply bits on a drive, replicated at the blink of an eye. Again, it doesn’t matter how much effort was needed to create said software; that’s a sunk cost. All that matters is how much it costs to make one more copy – $0.

The implication for apps is clear: any undifferentiated software product, such as your garden variety app, will inevitably be free. This is why the market for paid apps has largely evaporated. Over time substitutes have entered the market at ever lower prices, ultimately landing at their marginal cost of production – $0.

The same story applies for music, movies, content, etc., and this has fundamentally changed what it means to do business on the Internet. It’s why, for example, WhatsApp was so valuable to Facebook: attention is the true finite resource, and how it’s commanded is, in some ways, besides the point.

Bitcoin and the breakthrough it represents, broadly speaking, changes all that. For the first time something can be both digital and unique, without any real world representation. The particulars of Bitcoin and its hotly-debated value as a currency I think cloud this fact for many observers; the breakthrough I’m talking about in fact has nothing to do with currency, and could in theory be applied to all kinds of objects that can’t be duplicated, from stock certificates to property deeds to wills and more.

What makes Bitcoin so clever is how it assumes self-interest and uses incentives. To put it in the simplest possible terms, instead of a paid broker for transactions, tens of thousands of distributed computers working independently do the verification, at no cost to those involved in the transaction. Their reward is the possibility of more Bitcoin – the verification process is also the mining process. Most people are focused on the “mining” part of the process, but it’s the verification aspect that is profound.

Unfortunately, it’s not clear you can really divorce this verification process from the speculation involved with mining; it’s the speculation that incentivizes the verification. In other words, while the process behind Bitcoin enables unique digital goods beyond currency, the incentives only really work if said digital good has stored monetary value. Absent those incentives those doing the verification would need to earn some sort of commission, and then we’re right back where we started.1

Still though, currency is something – surely no-fee transfers is worth celebrating! And, as someone who regularly deals with wire transfers, I’m sympathetic to this point. Still, even if zero-fee transfers became seamless, Bitcoin as presently architected would be anything but free, and every one of us would have to pay the price.

The problem is the externalities of verification/mining. From the Wikipedia article on externalities:

In economics, an externality is the cost or benefit that affects a party who did not choose to incur that cost or benefit.

For example, manufacturing activities that cause air pollution impose health and clean-up costs on the whole society, whereas the neighbors of an individual who chooses to fire-proof his home may benefit from a reduced risk of a fire spreading to their own houses. If external costs exist, such as pollution, the producer may choose to produce more of the product than would be produced if the producer were required to pay all associated environmental costs. If there are external benefits, such as in public safety, less of the good may be produced than would be the case if the producer were to receive payment for the external benefits to others. For the purpose of these statements, overall cost and benefit to society is defined as the sum of the imputed monetary value of benefits and costs to all parties involved. Thus, it is said that, for goods with externalities, unregulated market prices do not reflect the full social costs or benefit of the transaction.

Recall the magic that makes Bitcoin profound: scores of independent computers all over the world running at full speed in the hope of capturing new Bitcoin, and in the process verifying transactions for free. Those computers need power, and that power needs to be generated. True, whoever owns the servers is paying a huge electricity bill, but (in most areas of the world) that electricity bill does not include the societal cost of pollution generated by electricity production.2

Moreover, the design of Bitcoin guarantees that electrical consumption increases dramatically indefinitely. Normally, you would expect the supply of computing power for a digital currency to initially increase, thus increasing the supply of said digital currency, which then lowers the price, ultimately reducing demand:

Under normal conditions, as the supply of computing power increases, the amount of a digital currency would increase as well. This lowers the price, eventually reducing demand.
Under normal conditions, as the supply of computing power increases, the amount of a digital currency would increase as well. This lowers the price, eventually reducing demand.

That’s not the case with Bitcoin though. Anticipating the amount of power that would be thrown at mining Bitcoin, Satashi Nakamoto built in a simple escalator that ensured new Bitcoin would be released about every 10 minutes no matter the amount of power being applied to mining/verification. This has effectively locked Bitcoin miners into a zero sum contest wherein greater and greater computing power serves only to steal opportunity from fellow miners; there is no corresponding increase in Bitcoin to be had.

Bitcoin is designed to be released on a regular schedule, no matter how much computing power is applied to it. This means supply will never catch up to demand, resulting in ever higher prices paid for with more computing power, i.e. more electricity.
Bitcoin is designed to be released on a regular schedule, no matter how much computing power is applied to it. This means supply will never catch up to demand, resulting in ever higher prices paid for with more computing power, i.e. more electricity.

The only possible increase is in computing power, which ultimately means Bitcoin effectively uses electricity as a release valve for inflation, compounding the externalities that accompany power production.

For what it’s worth, the structure of Bitcoin dictates that the price continue to rise, presuming it remains a viable currency (which is very much in question). That price, though, is not free, and no one asked me if I were willing to pay.

  1. In fact, Bitcoin, which has a cap on the total amount of Bitcoin that will ever exist, is ultimately headed this way ↩

  2. For the record, I am a major proponent of carbon taxes as both a means of reducing pollution as well as spurring innovation ↩

Netflix and Net Neutrality

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For anyone remotely connected to technology, the idea that net neutrality is an unabashed good seems incontrovertible, and one of the most popular examples of why it matters is Netflix. Consumers get a video competitor to their cable provider over said cable provider’s pipes; surely the end of net neutrality would mean the end of Netflix! For example, consider this section from Netflix CEO Reed Hastings’ 2014 letter to shareholders:

Unfortunately, Verizon successfully challenged the U.S. net neutrality rules. In principle, a domestic ISP now can legally impede the video streams that members request from Netflix, degrading the experience we jointly provide. The motivation could be to get Netflix to pay fees to stop this degradation. Were this draconian scenario to unfold with some ISP, we would vigorously protest and encourage our members to demand the open Internet they are paying their ISP to deliver.

And yet, just last week, Netflix – without much protest – did exactly what Hastings described: they paid Comcast to stop the degradation of Netflix’s services, and are expected to reach a deal with Verizon and other ISPs soon. The stock market promptly punished Netflix, sending the stock down 3.4 percent the day after the announcement.

Oh, wait, never mind: the stock was up 3.4 percent, hitting an all-time high of $447. This may be the opposite of what most tech observers expected, but Wall Street is not stupid: this is a great deal for Netflix, a company who has every incentive to not support true, end-to-end net neutrality.

Defining Net Neutrality

The first problem with the net neutrality debate is that there are three competing definitions:

  • The public definition – For most people, particularly those of us in the tech industry, net neutrality means non-discrimination against packets from origin to destination. A packet from Netflix or YouTube or PornHub or the New York Times is treated and priced the exact same from server to client and back again.

  • The legal definition – The FCC’s Open Internet rules, which were ruled as overreaching by the U.S. Court of Appeals in Washington, yet still apply to Comcast due to an agreement they signed as part of their acquisition of NBC Universal, only ever applied to traffic within an ISP’s network; in other words, once data is within Comcast or Verizon’s network, they can’t discriminate, delivering some data faster or slower. The Netflix/Comcast deal, on the other hand, is about peering: the point at which data enters the Comcast network (there is a useful overview of peering available here). This is not (and never was) covered by net neutrality, as many geeks are now learning to their dismay.

  • The Netflix definition – Netflix has a subtly different view, best articulated by Reed Hastings himself in a Facebook post two years ago:

    Comcast no longer following net neutrality principles.

    Comcast should apply caps equally, or not at all.

    I spent the weekend enjoying four good internet video apps on my Xbox: Netflix, HBO GO, Xfinity, and Hulu.

    When I watch video on my Xbox from three of these four apps, it counts against my Comcast internet cap. When I watch through Comcast’s Xfinity app, however, it does not count against my Comcast internet cap.

    For example, if I watch last night’s SNL episode on my Xbox through the Hulu app, it eats up about one gigabyte of my cap, but if I watch that same episode through the Xfinity Xbox app, it doesn’t use up my cap at all.

    The same device, the same IP address, the same wifi, the same internet connection, but totally different cap treatment.

    In what way is this neutral?

    What Netflix is most concerned about from a non-discrimination standpoint are broadband caps, and, more broadly, usage-based broadband pricing. It’s not that their position differs on a point-by-point basis from most net neutrality advocates; rather, the priorities are different.

Why the Comcast Agreement is Good for Netflix

This deal is in many ways a win-win for Netflix: they are likely paying less for better quality.

Previously Netflix paid backbone providers such as Cogent for transit; it was then Cogent’s responsibility to interface with last mile provides such as Comcast or Verizon. Cogent made a lot of noise about Comcast and other ISPs wanting to get paid on both sides – by customers for Internet access, and Cogent for peering agreements – but the truth is Cogent was just as duplicitous: they wanted to be paid by Netflix on one side, and effectively subsidized by ISPs on the other.

Free peering agreements between Internet providers were premised on the idea that a roughly equal amount of traffic was going in both directions, meaning there was no net increase in cost as a result of a peering agreement. Netflix, though, changed that equation by moving as much as 30% of all the United States’ internet traffic in one direction (on Cogent’s backbone). Cogent’s insistence on “free” peering, then, was not at all consistent with such previous agreements: Cogent was not carrying an in-kind amount of traffic in exchange for the traffic they were dumping onto ISPs.

As an analogy, suppose my friend Bob and I agreed to watch the other’s dog in the event of a trip or vacation. We both travel about three weeks of the year, so while I have to watch Bob’s dog for three weeks, he watches mine for three weeks as well. While the specific amount of travel may vary year-by-year, it all evens out in the end, and we’re both happy. A few years later, though, I take a job as a consultant, and am suddenly traveling 30 weeks a year. Wouldn’t it be unfair for me to insist that Bob hold to the terms of our agreement, even though it entails him watching my dog 27 weeks more than I watch his? Yet that is exactly what Cogent was demanding for direct access to ISPs’ networks, and the ISPs in turn demanded compensation (keep in mind, Netflix has always been free to use the open Internet to reach customers; they simply find the performance unacceptable and wants shortcuts into ISP networks).

With this deal, Netflix has effectively cut out the middleman Cogent, and is sending traffic directly from their servers onto Comcast’s network. Not only will this mean better quality for Netflix customers on Comcast, but it also raises the barrier of entry for potential Netflix competitors. Netflix currently has unique leverage over Comcast due to Comcast’s proposed merger with Time Warner, which, combined with their brand name and favorability amongst customers and regulators likely meant they got a great deal; future Netflix competitors, forced to go over the open Internet or rely on providers like Cogent will be at both a cost and quality disadvantage.

Most importantly, though, Netflix has to be thrilled that Netflix – not end-users – is paying for better Netflix video, shrouding the extent to which end-users are subsidizing Netflix.

Who Pays for Broadband?

There’s no question, at least in my mind, that broadband is just as much a requirement for day-to-day life as is electricity, water, sewage, paved roads, etc. And, like said utilities, broadband lends itself to a natural monopoly; the cost of capital for building out a network are so great that the economics demand a single provider.

The primary way to deal with natural monopolies is to either have said service provided by the government or provided by a private firm that is heavily regulated with strict requirements about widespread access combined with (relatively) high prices. This is indeed the case with electricity, water, sewage, and roads.1

The problem with regulating broadband in this way, though, is that the definition of acceptable broadband is much more of a moving target. As Marc Andreessen memorably put it on Twitter:

Remember, the United States is a country where one of the two major political parties routinely threatens to default on the nation’s debt to score political points. Infrastructure investment is embarrassingly low in things like roads and bridges, much less in environmentally sustainable power like nuclear;2 to put the future of broadband, something that requires continual investment, into the hands of such a dysfunctional government seems foolhardy at best.

And yet, the fact that wired broadband in particular is a natural monopoly remains, raising the question of how you incentivize investment in ever faster broadband? There are three main options:3

  • Government mandate – Given the assumption that broadband is a economic necessity, this is the prescription that follows. Unfortunately, the same pragmatic problems that make government-provided broadband a likely non-starter plague this as well; Republicans in particular have actively opposed any sort of telecom regulation, even before you get to the incentive problems of mandates versus markets.

  • Discriminatory pricing – Companies like Amazon know that every 100ms delay causes them to lose sales; that makes guaranteed access to end users exceptionally valuable. It’s the same thing with Google, Netflix, and most other Internet companies. Comcast and other ISPs would certainly be incentivized to improve their networks if they knew that said companies would compensate them accordingly.

    To some extent, this is exactly what just happened with the Netflix peering agreement, although true discrimination within their network would incentivize Comcast even more.

  • Usage-based pricing – With usage-based pricing, if you use more data, you pay more; use less, pay less. As we’ve seen with wireless, this strongly incentivizes network providers to increase broadband capacity. It’s no accident that the rollout of LTE in the US was combined with the imposition of data caps, just as it’s not an accident that the US has far better LTE penetration than anywhere else in the world. This despite the fact that providing wireless service in the US is much more difficult than just about anywhere else in the world due to sheer physical size and effective NIMBYism.4 AT&T, Verizon, etc. want you to use as much data as possible as quickly as possible, and to charge you for the privilege.

Making Tradeoffs

In the end, each of these options presents a different set of tradeoffs among three competing ideals:

  • Continual investment in faster and more accessible broadband
  • Non-discriminatory treatment of data
  • Unlimited access

There is no approach, at least given the United State’s political realities, that allows for all three; this is “Fast/Good/Cheap Choose Two” applied to Internet access.

Thus, we need to make choices based on priorities. From my perspective, the most important of these ideals is the non-discriminatory treatment of data. This is what makes the Internet so profound, and what enables new companies to disrupt the market and improve the lives of millions. It must be protected not just within an ISPs network, but all across the entire Internet including peering.

The second most important is continual investment in faster and more accessible broadband. The flip-side of the Internet being so profound is that improved access has an exponential return both from an economic as well as from a societal impact perspective.

That leaves unlimited access on the chopping block. While I love the idea of unlimited data, I also am aware that nothing comes for free; in the case of unlimited data, the cost we are paying is underinvestment and/or discriminatory treatment of data. Therefore I believe the best approach to broadband is usage-based payment by both upstream and downstream, with no payments in the middle.

The way this would have played out in the case of Netflix is that:

  • Netflix would pay more at the point of origin to compensate backbone providers for the massive amount of data they generate
  • ISP customers who watch the most video would pay more

It’s the latter result that terrifies Netflix, and is why, in the end, they are not an ally of those of us who desire true net neutrality. Currently non-Netflix broadband subscribers are effectively subsidizing Netflix viewers; they use much less capacity, yet pay the same price. This needs to change for the sake of true net neutrality, and if it results in Netflix losing subscribers, so be it.

Unfortunately, this agreement and the others that are soon to follow makes such an arrangement unlikely. Comcast and company are getting paid, so they’re happy, and Netflix is disguising their true cost to end users so they are happy as well. It’s non-Netflix users, and, more distressingly, the startups and services that have yet to be created who are ultimately paying the price.

  1. Problems with these models arise when pricing becomes unregulated, or not included at all ↩

  2. If there is one thing to take away from this article as a whole, it is that everything is a tradeoff. I know my aside on nuclear just upset a lot of you, but when you consider the relative cost and capacity of wind, solar, etc, and the environmental destruction caused by fossil fuels, non-polluting nuclear and its spent fuel risks makes a lot of sense. Tradeoffs. ↩

  3. Google Fiber is a fourth: building a straight-up competitor, natural monopoly economics be damned. It’s possible because Google already has its own backhaul network, but I have trouble seeing how it will scale at least in the near term ↩

  4. NIMBY = Not In My BackYard ↩

The Nokia X

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It’s real, and the Verge had a hands on:

As expected, [the Nokia X, X+ and XL] combine Lumia-style design with low-cost hardware aimed at the masses, from a large 5-inch screen on the 109-Euro XL to the 4-inch display on the 99-Euro X+. The X will be released for just €89 in Eastern Europe, Asia, South America, and a few other global locations, but it won’t be making its way to North America, Japan, Korea, or Western European countries. These aren’t competitors to Samsung’s Galaxy S4 or Apple’s iPhone 5S, and there are certainly no surprising hardware additions like a 41-megapixel camera or a giant 6-inch display. Instead, the standout feature of the Nokia X lineup is the software that powers it: Android.

During the presentation, Stephen Elop – still at Nokia! – was very explicit that the ability to run Android apps would be a selling point. From the keynote:

Ladies and Gentleman, the new Nokia X and X+. Both of them run Android applications, they include unique Nokia experiences, and they include a wide array of popular Microsoft services…The Nokia X and X+ are built on the Android Open Source Project software which means people have access to hundreds of thousands of applications right out of the box. People can access free applications from the Nokia store, but as well you can access applications from other application stores. People can sideload applications using an SD card with our file manager…

The Nokia X takes people to Microsoft’s cloud, not to Google’s cloud. This was very deliberate, because the Nokia X family, with this Microsoft will be able to reach people it has never talked to before around the world.

ReadWriteWeb has a useful overview of the app situation: The vast majority of apps that don’t use location or notification services will run as-is. Developers need only upload the applications to the Nokia store, or have them already listed in alternate Android stores like Yandex or GetJar. For the rest, Nokia is providing drop-in replacements for payments, location, and notifications, and says it takes less than a day to have an app ready for their store

Of course, the app situation isn’t as good as it could be: were Nokia a standalone company, their best shot would be to use the Google Android experience with the full Play store, something I argued they should have done many years ago. But Nokia, soon at least, won’t be a standalone company; they will be a part of Microsoft, and if that means Google isn’t an option, then this is clearly the best alternative. There’s little question the Nokia X is in a much better position than Nokia’s ostensible top-of-the-line Lumias when it comes to apps.

In fact, that’s the biggest hole in the Nokia X’s reason-for-being: it’s supposed to be an entry-level device that will help move people up to Lumias, but if said move requires losing half your apps, in what direction are you moving? It is the Lumias that should be adopting the exact same OS, with the exact same app strategy.

Think about it: in the big picture, what is the point of having a Microsoft-built OS? If the goal is to make money, as Steve Ballmer so often stated it was, then the only future for Microsoft on mobile is services, not cut-rate devices. And, if both AOSP and Windows Phone can provide access to those services, why not use the platform that is orders of magnitude easier for developers to support?

Microsoft is so far behind in mobile that they simply cannot afford to fight battles that, in the big picture, don’t matter. And, for a services company, an OS battle is exactly that.

Some additional notes:

  • Even if it’s trivially easy for Android developers to support the Nokia X, why should they when it’s not clear whether or not it will survive the year? Microsoft may not be able to comment now, but they need to clarify their position as soon as possible.
  • The above point – that Microsoft can’t afford to fight the OS battle – applies even more strongly to Internet Explorer. Just as the web made the Mac viable, Microsoft ought to pray the mobile web makes their devices more viable as well. They can help by adopting WebKit, ensuring every site works perfectly on all their devices. And, to be honest, Apple could probably use the help.
  • It’s too bad this is only being released on such low-end devices. If the Nokia X fails, the cause of failure will be less clear than it might have been.

The Social Conglomerate

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When news of the Facebook/WhatsApp deal broke, a lot of people gave me credit for being prescient: after all, I had just written 1,568 words on why messaging was mobile’s killer app. WhatsApp, though, was all but absent from the article, meriting but a single mention, and in parenthesis at that!

Viber does have strong user numbers, claiming 280 million registered users and 100 million monthly active users, and that is certainly a big part of the battle, but the creation of a meaningful platform is a significant next step that Viber (and WhatsApp) has not taken. A platform is about multi-sided markets; LINE and WeChat are so valuable because they not only have the users, but also advertisers, commerce sites, and developers.

Thus, while I’m skeptical of Rakuten and Viber, for LINE and WeChat the sky is the limit. Both have effectively built platforms on top of iOS and Android and smack dab in the middle of the most meaningful, and thus most-used, part of our lives: our communication and interaction with those we know and care about.

Thus the reason for the exclusion: I believe that business models matter, and while WhatsApp had the users, I’d heard enough about their (admirable!) principles to think they weren’t interested in either selling out or in building the sort of platform necessary to convert those users into a multi-billion dollar company.

I think that’s the first thing to understand about the $19 billion Facebook paid (including $3 billion in RSUs); WhatsApp as a standalone company, at least as presently constructed, with a miniscule staff and $1/user/year revenue model, was not worth anything close to $19 billion. But, that does not mean that Facebook overpaid.

Facebook Is Solely Focused on Attention, Not Monetization

There were two primary points I made in Messaging: Mobile’s Killer App:

  1. Messaging on mobile means constant communication with those closest to us. Those two words – constant, and closest – make it inevitable that messaging occupies more of a user’s attention than any other service.
  2. Messaging has a unique monetization model: platforms that combine direct marketing with immediate monetization opportunities

WhatsApp was hugely competitive when it came to the fight for user attention, but not really in the game when it came to platform-building; that’s why my post was mostly focused on LINE and WeChat: both have more potential as standalone companies than WhatsApp (not that Tencent would ever spin off WeChat!). Facebook, though, also doesn’t care about point number 2 – more about this in a moment – even as they care very deeply about point number 1, and from that perspective, WhatsApp is by far the most valuable of the messaging services. To put it another way, context matters: are you considering only messaging services, or are you considering the entirety of social?

Facebook is Building a Social Conglomerate

For several years Facebook-the-company sought to include the entirety of social interaction within Facebook-the-product. I tried to explain why this wasn’t possible last November in a post called The Multitudes of Social:

Last week Snapchat reportedly turned down a $3 billion dollar all-cash offer from Facebook. Apparently Facebook was worried about losing the teen demographic, or perhaps they were unnerved by the 350 million photos Snapchat claims to process per day. What seems clear, though, is that Facebook is intent on “owning social.”

The only problem with this strategy is that the very idea of owning social is a fool’s errand. To be social is to be human, and to be human is, as Whitman wrote, to contain multitudes. Multitudes of apps, in my case.

I obviously underestimated Mark Zuckerberg (I take solace in the fact I have lots of company on this point). While Zuckerberg may have given up on Facebook-the-product owning social, he remains determined that Facebook-the-company do just that. Thus the drive to release multiple standalone apps, and, more pertinently, the acquisition of first Instagram and now WhatsApp.

It was while writing The Multitudes of Social that I first created the Social/Communications Map; regular readers may be tired of it by now, but I think it’s essential to understanding what is happening:

The Social/Communications Map
]1 The Social/Communications Map

The big issue for Facebook-the-product is that while it has successfully extended itself into the public permanent broadcast segment (the blue dashed arrow), by doing so it has denied its brand permission to move into the private and ephemeral regions of the map. Facebook is irretrievably associated with content that you don’t want to risk haunting you in the future, and which you can never be sure is totally private. This was an acceptable tradeoff in the PC era; PCs are destination devices, and the relative effort it took to post pictures or status updates meant users were naturally inclined to put their best foot forward.

Mobile, though, because it is everywhere, captures far more human interaction; the majority of said interaction is ephemeral and private, and thus incompatible with what Facebook-the-product stood for. Facebook tried breaking in with products like Camera and Poke, but the Facebook association – and head start of competitors – was too much. And so, Facebook has bought its way in to the majority position in the category that dominates human interaction.

This is why I 100% believe Jan Koum when he says that WhatsApp will remain autonomous, at least from a product and branding perspective. To glom WhatsApp onto Facebook-the-product would be to throw away exactly what makes WhatsApp valuable to Facebook-the-company – that it’s not Facebook-the-product. It is better to think of Facebook-the-company as a conglomerate: Facebook-the-company builds, acquires, and manages multiple products that serve all the different segments of social. The largest and most well known product in their portfolio just happens to be called “Facebook” as well.

Facebook Doesn’t Need to Monetize WhatsApp

Describing Facebook-the-company as a conglomerate also explains the WhatsApp monetization riddle: namely, there is no need. The Facebook product division is absolutely crushing it and will make more than enough money with an excellent growth rate for many quarters to come. Moreover, its primary product – immersive display ads – are a perfect match for another company in the Facebook portfolio, Instagram, leaving WhatsApp free for the foreseeable future to asymmetrically compete1 with LINE and WeChat for users in the private ephemeral space. I’d imagine the first step will be making WhatsApp completely free.

Even without immediate monetization, though, WhatsApp will provide immediate value to Facebook-the-company in two ways:

  1. As Facebook works to federate WhatsApp’s userbase with the Facebook userbase they will increasingly be able to harvest signal about users in a way that increases the value of Facebook-the-product’s display ad business.
  2. WhatsApp will provide great option value to FB the stock. Kakao is reportedly filing for a $2 billion IPO, and LINE is expected to do the same later this year for $10 billion; investors will (rightly) presume that Facebook-the-company could similarly monetize WhatsApp if they chose to, increasing FB the stock’s upside.

The Messaging Space Going Forward

This deal is both good and bad news for the other messaging services. On the plus side, the eye-popping price should have a significant upward effect on the other messaging services’ valuations. On the other hand, WhatsApp now has significantly more resources, and, perhaps more importantly, significantly different incentives over the long run. Zuckerberg and company’s focus is not on building something sustainable, but rather on dominating the entire space.

That said, WhatsApp does not dominate everywhere, and its position in Asia in particular – especially the richer countries – has been a bit oversold:

  • WeChat dominates China and is making inroads into Vietnam
  • LINE dominates Japan, Taiwan and Thailand and is making inroads in Vietnam, Indonesia, Spain and Mexico
  • Kakao dominates South Korea

In several of these countries WhatsApp was originally the leader, but the more full-featured competitors have since taken over. It will be interesting to see if Facebook responds by aping things like stickers, although a pure platform strategy along the lines of LINE seems less likely in the short-term.

One more note on messaging: it’s both more, and less, sticky than you might think. There are absolutely network effects at play: the best service is the one your friends are on. However, features like push notifications and badges makes it trivial to manage multiple networks; for example, most of my friends in Taiwan are on LINE, but it’s easy to respond to others who prefer WhatsApp, WeChat, Hangouts, or Facebook Messenger. I even make them share a badge!

Multiple messaging apps are easy to manage
Multiple messaging apps are easy to manage

Once again, it’s context that rules the day: different apps for different friends in different countries, but rarely multiple apps for the same groups and/or countries.

The Age of Conglomerates

This idea of conglomeration – ever larger companies, delivering ever more specialized and segmented products – isn’t limited to just Facebook. Google is arguably a machine-learning conglomerate with multiple products; Amazon a logistics conglomerate with multiple services; even Apple a personal computer conglomerate offering multiple products with different form factors and interaction models.

And, considering how computing power increases even as prices decrease, more specialized products that more perfectly fit different use cases is a natural result. So it is with Facebook-the-company: they are the social company, and no one can question their determination to offer a product that fits every use case, no matter the cost, and no matter the brand.

  1. Meaning, they don’t need to worry about monetization ↩

Messaging: Mobile’s Killer App

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Before the Internet, the nodes of communication were houses, and the killer app was the telephone. Presuming both you and I were in our respective houses, I could dial a number, and we could talk. It was marvelous, and in retrospect, primitive; real-time is much less interesting, and much more limiting, when it’s the only means of communication.

In the late 1970s, the computer came along, and while it made us incredibly more efficient, it didn’t truly alter the definition of communication. That took the world wide web, and its killer app: the browser.

Now the nodes of communication were computers, and while real-time was still a possibility, it was passive communication that defined the web. I, along with every individual and organization on earth, could create a web page, and you could view it, at a time convenient to you. The place, though, was only at the computer.

Seven years ago, the computer became pocketable, but the original use cases were about making the passive presentation of information accessible not just at a time convenient to the viewer, but also at any place: the web was now everywhere.

Still, it’s only recently that the killer app for this era, when the nodes of communication are smartphones, has become apparent, and it is messaging. While the home telephone enabled real-time communication, and the web passive communication, messaging enables constant communication. Conversations are never ending, and friends come and go at a pace dictated not by physicality, but rather by attention. And, given that we are all humans and crave human interaction and affection, we are more than happy to give massive amounts of attention to messaging, to those who matter most to us, and who are always there in our pockets and purses.

It is only in this context – that mobile dominates because our phones are always with us, and that messaging is its killer app – that you can make sense of Rakuten’s $900 million acquisition of Viber. Or, for that matter, understand why LINE is gearing up for a $10 billion IPO, or why WeChat has helped double Tencent’s stock price in the last year, or why both Twitter and Facebook/Instagram launched enhanced messaging products last fall.

The demand for attention, though, is only part of what is happening. After all, while capturing attention is critical for advertising-based companies like Twitter and Facebook, it would seem like it’s of lesser importance to an e-commerce giant like Rakuten. To that end, Hiroshi Mikitani, the co-founder and CEO of Rakuten, was remarkably concise about his motivation in an interview with Re/code:

“Messaging apps are taking over the world and, while search is one of the strongest platforms, what is happening in communications is very, very important…”

“We have content and games and commerce and markets and services, but they need the ability to reach out and talk to customers wherever they are,” said Mikitani. “With this, we can make buying more secure, but also more human.”

Think about commerce in the same time periods and contexts I recounted above: in the time of addresses and telephones, most commerce involved driving to the store. It was a purposeful and burdensome activity, rather like a scheduled phone call. In the era of the web, ecommerce became a word, but it still entailed going to a computer, a journey that seems simple, but in reality is often far removed from the motivation to buy, which may arise from an ad seen on TV, or a dress in a windows, or the recommendation of a friend. With mobile though, and particularly with messaging, the omnipresence of both a communications channel as well as a purchasing channel means the separation between the thought of buying and actually making a purchase is very small indeed.

The path to purchase is usually presented as a funnel, and looks something like this:

funnel

Google has made its fortune by living near the bottom of that funnel: people search for items they already desire. Reaching them at that moment means a much shorter and obvious path to action, i.e. purchase, and it’s is worth an incredible amount to advertisers on a per-user basis.

In absolute volume, though, awareness and interest make up the largest portion of advertising spending. This isn’t a surprise; the very concept of a funnel is that the top must be much wider than the bottom. This has also been the most difficult part of the funnel for technology companies to break into in a meaningful way; up till now the primary means of demand generation has been display advertising, and it hasn’t been very good. Facebook, though, is making massive strides here, particularly in mobile (I detailed why in an article last summer called Mobile Makes Facebook Just an App; That’s Great News).

Where messaging has a potential to make a mark is in the middle: moving customers from interest to desire and on to action, through one of the oldest and most reliable forms of advertising – direct contact.

In the house context, direct contact took the form of postal mail, and in the computer context, email. Both certainly became huge targets for abuse in the form of spam, but that’s because direct marketing works. Consider a legitimate marketing mail you might receive (analog or digital):

  • You have already indicated that you like a particularly store or brand and have given them your contact information. There is no need for expensive and intrusive targeting.
  • It’s likely that you have made previous purchases, decreasing the friction in future purchases, particularly if your payment information is stored on the company’s servers1
  • In the case of email, you are likely reading the marketing message in a context that also enables immediate action; simply click a link and the item is in your shopping cart

All of these positive factors apply to messaging. Here is one way it works (all of the examples I’m going to use are from LINE, but they almost all apply to WeChat as well):

haagendasz

  • This is a sticker set from Häagen-Dazs; they have paid LINE tens of thousands of dollars (varies by market) to make this set available for free
  • To get the stickers, users must follow the official Häagen-Dazs account
  • Voilà, Häagen-Dazs now has a direct communications channel to millions of users

Perhaps this summer, when it’s particularly hot, Häagen-Dazs will send out a coupon to all those users for a discounted cup of ice cream. Many of those users will be out-and-about, likely in the vicinity of a Häagen-Dazs retail shop (they’re all over the place in Asia). And just like that customers have been moved to action.

This is an example using physical retail, but the effect is even more powerful with e-commerce: simply click a link wherever you are and you’re on the verge of action. To that end, LINE has been experimenting in Thailand with flash sales, and the results were pretty incredible: of the 22 million Line users in Thailand, 5.5 million users participated.

It’s digital goods, though, that really make this channel shine, particularly apps. Consider this user flow, again from LINE:

LINE Platform example

My wife has sent me a notification from a LINE game; to open it I need to download the app, which authenticates with my LINE chat app, and I’m good to go. The game, as you might expect, is simple, fun, and laced with in-app purchases. It’s why gaming revenue made up 60% of the company’s $120 million in revenue in 4Q 2013, which was a 450 percent increase year-over-year (20% was from for-pay sticker packs, and the rest from sponsorships like Häagen-Dazs and merchandise – LINE characters are the next Hello Kitty).

Revenue and growth numbers like these, along with the potential for mobile commerce, in some sense make $900 million for Viber seem cheap. But I’m not convinced that this purchase is going to turn out for Rakuten any better than Kobo or Buy.com, other 2nd-tier assets the company has acquired over the years. Viber does have strong user numbers, claiming 280 million registered users and 100 million monthly active users, and that is certainly a big part of the battle, but the creation of a meaningful platform is a significant next step that Viber (and WhatsApp) has not taken. A platform is about multi-sided markets; LINE and WeChat are so valuable because they not only have the users, but also advertisers, commerce sites, and developers.

Thus, while I’m skeptical of Rakuten and Viber, for LINE and WeChat the sky is the limit. Both have effectively built platforms on top of iOS and Android and smack dab in the middle of the most meaningful, and thus most-used, part of our lives: our communication and interaction with those we know and care about.

The Social/Communications Map
The Social/Communications Map

Facebook will continue to own people’s public representation of themselves, and the sort of voyeurism that entails is a good match for their display advertising. LINE and WeChat are similarly aligned with their monetization models: just as their interactions are more intimate, the connections between marketers and users are much more direct. They are perhaps the most important companies to come of age in the mobile era.

  1. This is why companies won’t give up storing credit card details, no matter how many attempted hacks they may have to endure. The dropoff from a customer needing to enter a credit card number is far more expensive than the bad publicity that is the primary punishment ↩

Microsoft v Microsoft

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In his first column for the New York Times, Farhad Manjoo advocated relying on Apple, Google, and Amazon:

When you decide what to use, you’ve got to play every tech giant against the other, to make every tech decision as if you were a cad — sample every firm’s best features and never overcommit to any one.

I rather agree with and follow Manjoo’s advice, and my reasoning is all about the incentives that arise from Apple, Google, and Amazon’s business models:

  • Apple makes money when you buy devices, and they differentiate those devices by making their own operating system. This incentivizes them to make the best devices and best operating system, and, in my opinion, they do
  • Google makes money when you access their services. This incentivizes them to make their services available, with the best possible implementation, everywhere, regardless of device. And, in my opinion, they do
  • Amazon makes money when you buy stuff. This incentivizes them to make their store and content available, with the easiest possible access, everywhere, regardless of device. And, in my opinion, they do

One person who didn’t agree was Frank X. Shaw, Microsoft’s chief spokesman, who was miffed by Microsoft’s conspicuous absence from Manjoo’s recommendations:

So while your readers could take your advice and blend in with the current crowd, we’d encourage you (and them) to take a look at some alternatives that offer even better ways to get things done. And with a cross-platform connected ecosystem that spans the workplace to the living room featuring best in class products like Office, Skype and Xbox, we’re a pretty safe bet too.

Actually, no, Frank, you aren’t, and your colleague, Tami Reller, explained why at the Goldman Sachs-sponsored technology conference when asked about Office – Microsoft’s most indispensable service – on iPad and Android. As recounted by ComputerWorld:

“As we step back and say, these core applications, these core brands that are so important to enterprise customers and consumers, how do we make sure that we’re thoughtful about what we’re doing on the Windows platform, as well as cognizant of the fact that there’s other devices in their lives (emphasis in original),” Reller replied when she was asked about the status of the decision to put the productivity suite on other operating systems…

A follow-up question from the moderator brought even more from Reller, who talked about the importance of differentiating Windows to customers, both end users and OEMs (original equipment manufacturers), the vendors that make and sell devices. “A part of that [differentiation] is Office, for sure,” Reller said.

If that wasn’t clear enough, Reller pointed out that changes to Office’s platforms would be a business decision, not one based on customer requests.

“We come at it from that angle, which is ‘What businesses do we need to drive forward?,'” said Reller. “That’s how we will make the decision [to go cross-platform]. It really ends up being business by business, product by product. There’s no sweeping one decision.”

So to summarize, Office is not available everywhere, and probably won’t be anytime soon, because Microsoft has a devices business to prop up. Oh, and Microsoft’s business needs are a priority over user needs. Tell me, Frank, how is that a safe bet?

The truth, as I’ve written multiple times (here, here, and here), is that a “Services and Devices” strategy is fundamentally flawed. Either be everywhere with your services, or differentiate your devices. And, given this:

Methinks being everywhere with services is a much more sustainable strategy. And, perhaps, one that would earn Manjoo’s – and my – recommendation.

Microsoft’s Mobile Muddle

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Saying “Microsoft missed mobile” is a bit unfair; Windows Mobile came out way back in 2000, and the whole reason Google bought Android was the fear that Microsoft would dominate mobile the way they dominated the PC era. It turned out, though, that mobile devices, with their focus on touch, simplified interfaces, and ARM foundation, were nothing like PCs. Everyone had to start from scratch, and if starting from scratch, by definition Microsoft didn’t have any sort of built-in advantage. They were simply out-executed.

Not that that should make Satya Nadella sleep any better at night. The power of mobile is that it is always with you; it is impossible for your mobile device to not dominate your computing time. At first, said time was accretive: on the bus, in the waiting room, the seams in your life. Increasingly, though, mobile is stealing time formerly devoted to PCs, making mobile not just a threat to Microsoft’s growth, but also to their cash cows.

To appreciate the extent of Microsoft’s problems, and the possible solution, I’ve broken things down in five categories:

  1. Business Models
  2. Devices
  3. Services
  4. Patents
  5. Apps

The realities of mobile

  1. There are two viable business models: device sales and services. Licensing an operating system for profit is a non-viable business model. Android killed it.

  2. A sustainable device sales model requires differentiation (e.g. the iPhone), channel and supply chain dominance (e.g. Samsung), or extremely competitive cost structures (e.g. Lenovo and most other Chinese manufacturers). All require huge volumes to reap economies of scale.

  3. A sustainable services model requires touchpoints on as many devices as possible, a massive cloud infrastructure, and a means of monetization (e.g. Google services on all devices, not just Android, all harvesting signal to be used in advertising).

  4. Patents are a significant part of the cost-of-goods in developed markets, perhaps 15-20% of the selling price. This can be significantly more (or less) depending on the amount of patents that a manufacturer can use for cross-licensing with other smartphone manufacturers (which reduces the amount needed to paid in royalties). However, patents (and their associated costs) are mostly ignored in China, Indonesia, and other large developing markets.

  5. An extensive app store that contains not only well-known titles but day-to-day utilities like banks, airlines, etc. is no longer a differentiator but a price of entry.

Microsoft’s Situation

  1. Windows Phone (and Windows Mobile before it) was developed with the intent to license the operating system for a profit. That model is no longer viable; only 10% of Windows Phones are built by non-Nokia OEMs, and that percentage is expected to fall.

  2. Microsoft has acquired Nokia with the intent of pursuing a devices business model. However, while Lumia smartphones have great cameras and build quality, they are negatively differentiated by the lack of a competitive app store, are not built at massive scale, and have only sold successfully at extremely low prices with no profit margins.

  3. Microsoft Office has long been available on Windows Phone devices, but has only recently had a limited version published on the Apple and Play App Stores (phone only). Bing and Outlook are options on iOS, but not defaults. Onedrive is available in both the Apple and Play App Stores. Azure offers cloud resources for both iOS and Android app developers.

  4. Microsoft has an extensive patent portfolio and is reportedly earning $2 billion a year from Android device manufacturers.

  5. The Windows Marketplace has slowly captured most top apps (Facebook, Twitter, and finally Instagram), but is always years behind hot new apps (e.g. Snapchat), and has major holes in “utility” apps like banks, airlines, etc. Microsoft has zero leverage over developers.

What Should Microsoft Do?

  1. Choose between devices and services. The problem with pursuing both, as Microsoft is doing, is that strategy taxes are inevitable. If you favor your devices by giving them better services, you are by definition limiting your services on competing devices. Meanwhile, by offering your services on competing devices, you are limiting the competitive advantage of your devices. Compare this morass of a strategy with Google’s clear focus on services (Google services on iOS are just about as good as on Android) and Apple’s clear focus on devices (iCloud is only available on iPhones).

  2. Abandon devices. The devices business is only worthwhile if you are able to sell at a high margin; while this does not offer the margin percentage of software licensing, the absolute monetary value of a high margin device is significant ($300+ for an iPhone, for example). However, Lumia’s are simply not competitive at the high end; all volume to date is that the very low end (<$150), and is being sold at a loss. Moreover, Lumia volume is too low to be supply chain competitive, at least once the former Nokia feature phone business is spun off. Ideally, sell the entire division to a Chinese manufacturer that is not aligned with Google (Lenovo’s acquisition of Motorola was a blow here; they are committed to Google Android, and it will be mostly stock).

  3. Embrace services. Services seek to touch every device, and, as I’ve written previously, are much more suited to Microsoft’s culture. Moreover, Microsoft has many of the pieces already in place, along with their primary remaining trump card: Office. Microsoft should use this trump card with Apple specifically: offer Office on iPad exclusively for a specified time in exchange for Bing as the default search,1 fuller iCloud integration with Azure, and/or built-in Xcode support for Azure cloud services.2 Apple has most of the best customers – the ones who will pay for services; Microsoft needs those customers desperately, and Nadella should go hat in hand to Cupertino.

  4. Fork Android and offer a version of AOSP (Android Open Source Project) with Microsoft services, app store (more on this below), and, most importantly, patent protection to Chinese manufacturers.

    This is the most misunderstood aspect of the Lenovo-Motorola deal; Motorola was worth more to Lenovo than almost anyone else because the deal included the right to cross-license Motorola’s patents. Without the ability to cross-license patents with other smartphone manufacturers, royalty fees can balloon far beyond the 15-20% of a phone’s cost that I referenced above; this would effectively destroy Lenovo’s cost-structure advantage.3 It is for this reason that Lenovo has only sold phones to date in countries with poor IP-protection; the Motorola patents let them go abroad much more competitively.

    The situation is no different for the other Chinese manufacturers like Coolpad.4 Patents have built an effective wall against Mediatek-powered Chinese manufacturers, leaving Android-powered Samsung dominant in most developed markets; Microsoft is uniquely positioned to enable and encourage said manufacturers, who are already competing strongly against Samsung in China, do the same in the rest of the world. They would all use Microsoft services abroad in exchange for patent protection, just as they use non-Google Chinese services in China.

  5. Build an AOSP Play Store with word-for-word copies5 (to the extent technically possible) of Google GSM APIs, and incentivize Microsoft’s global platform evangelists to encourage every Android developer to change a few lines of code and submit to the Microsoft AOSP App Store. Developers won’t be upset that they are being asked to abandon their Windows Phone app; on the contrary, they will love the fact they no longer need to support a platform that hasn’t come close to providing a return on investment.

    (I am aware of Peter Bright’s article that says Android is unforkable; I find it technically accurate but misleading. Of course there are some APIs in GMS, but a tiny amount relative to AOSP, and almost all related to cloud services which Microsoft by definition wants to replace. Bright waves this away by saying it’s “too much work,” but it’s much more work trying to get developers to build entirely new apps than it is to get them to change a few lines of code to support your store. Sure, Google might try to mess things up, but far better to rely on your own ability to adjust than on developers over whom you have no leverage.)

To say this strategy would be a stark departure from Microsoft’s current course is, obviously, an understatement. It’s also the point – Microsoft’s current mobile strategy is an objective failure. With the Nokia acquisition Steve Ballmer threw good money after bad, and every moment spent pursuing a devices strategy based on a stillborn platform6 is another day that endangers the strengths Microsoft still possesses in the cloud and especially in the Office franchise.

One does wonder, probably naively, if this is the reason Bill Gates came back. To abandon an operating system strategy for an operating system company, no matter how improbable the chances of success, and to embrace one’s former rival (Apple), will require extraordinary amounts of political capital – amounts possessed by no one but the founder.

The precedent, of course, is Steve Jobs telling Macworld in 1997:

We have to let go of this notion that for Apple to win Microsoft has to lose. We have to embrace a notion that for Apple to win Apple has to do a really good job, and if others are going to help us, that’s great, cause we need all the help we can get…The era of setting this up as a competition between Apple and Microsoft is over as far as I’m concerned. This is about getting healthy, and this is about Apple being able to make incredibly great contributions to the industry, to get healthy and prosper again.

So it is for Microsoft. They need Apple and iOS, and, just like Apple had to get back to its roots of making great products, Microsoft ought to return to its roots of embracing and extending.

  1. Bing as default would surely be attractive to Apple for strategic reasons, but they could face the same blowback as Maps, and rightly so; Google is better ↩

  2. One of the three would be a win ↩

  3. This is one of the many problems facing HTC ↩

  4. Huawei is an exception; they have a much more extensive patent portfolio because of their telecom infrastructure business ↩

  5. Google has already provided the legal justification in the Oracle case ↩

  6. Warning: Tomi Ahonen link, but I swear it’s 80% rational and a good refutation of the spin that Windows Phone is making significant progress ↩