I once again joined Rene Ritchie on his Vector Podcast to talk about the CEO change at Microsoft (and the return of Bill Gates), along with Lenovo’s acquisition of Motorola. I added quite a bit of color as to why this deal made sense for Lenovo, particularly from a patent perspective, as well as why I think Google always planned to spin out Motorola. We also spent a bit of time on what ails Apple and Samsung.
Along the way we touched on mature versus immature markets, vertical integration versus modularization, and why product is a necessary but insufficient ingredient in market success.
Steve Jobs and Bill Gates, once pirates, now legends, are forever linked in tech history. You know the lore: both collaborators and competitors in the 80s; Gates dominant in the 90s; Jobs triumphant in the 00s. Their career arcs were different though: Gates went out on top, retiring to a life of philanthropy, while Jobs spent a decade in the wilderness, returning to Apple at its darkest hour and leading it to impossible heights.
It turns out, though, the story may not be over.
Yesterday Satya Nadella was named CEO of Microsoft. In the same press release, though, was Gates:
Microsoft also announced that Bill Gates, previously Chairman of the Board of Directors, will assume a new role on the Board as Founder and Technology Advisor, and will devote more time to the company, supporting Nadella in shaping technology and product direction.
It’s been widely reported, particularly by Kara Swisher at Re/code, that Gates has been increasing his involvement at Microsoft, has been driving the CEO search, and has favored Nadella from the beginning. Moreover, it’s highly likely that Gates was the ultimate factor in Steve Ballmer’s abrupt retirement.
Taken together, it’s difficult to escape the conclusion that Gates is back, with Nadella on board to handle the non-product and time-consuming aspects of being public-company CEO. It’s positively Jobsian. To be clear, unlike Jobs, Gates has remained involved with Microsoft even after his departure, and Microsoft is in much better shape financially then Apple was in the 90s. In other ways, though, the challenge Gates and Microsoft face today are far more formidable.
Even in the 90s, Apple had a sustainable target market, particularly designers and publishers. That is why Adobe Photoshop was, along with Microsoft’s $150 million investment into Apple, a central focus of Jobs’ first keynote back at Apple. More importantly, though, thanks to painful layoffs instituted by Gil Amelio, Apple was a small enough company that such a limited market was enough if only they could start making good products. And good products is exactly what Jobs helped deliver. Moreover, considering Apple’s marketshare and the portable revolution to come, growth opportunities were effectively infinite.
Microsoft has strong positions in much larger markets, namely PCs running Windows, productivity software that runs on those PCs, and enterprise data center software that serves those PCs; but a much larger employee base as well – over 100,000 currently, before you add in the 30,000 being added in the Nokia acquisition. Unlike Apple in the 90s, there isn’t much headroom: PC sales are collapsing, and threaten to drag down Office and Server sales if not now, then in the long run. Meanwhile, efforts in search, consoles, phones and tablets aren’t even close to making up the slack, particularly from a profit perspective.
The issue for Microsoft is that the problem – and relatedly, the solution – is not (just) the quality of the products, or lack thereof. The same kinds of network effects and developer support that Microsoft leveraged to dominate with Windows now work against them in phones and tablets, and it’s too late to build an OS that will contribute in a material way to the bottom line. Meanwhile, PCs are being relegated to specialist devices by more accessible devices like the iPad, which, when combined with the reduction in meaningful advances in computing power for day-to-day use, has stretched out the replacement cycle, effectively reducing Microsoft’s income from Windows. Neither better phones nor a better version of Windows can change these structural headwinds.
Given this reality, if Gates’ impact is limited to “technology and product direction”,1 then his return is likely to be more Michael Jordan with the Wizards2 than Steve Jobs with Apple. What is needed is a fundamental rethinking of Microsoft’s role in technology:
Admit Google and Apple have won the OS war for phones and tablets
Refocus Windows on securing the (shrinking) PC market
Massively accelerate the buildout of services like Azure and Office365 on all devices, especially iOS and Android
Simple, right? Unfortunately, anything but, especially for Gates:
Gates is insanely competitive, and there is a massive gulf between the reality of the market for phone and tablet OS’s and Microsoft’s perception of itself as an OS company. Moreover, Microsoft’s recent moves, particularly the purchase of Nokia, work in the opposite direction. A sale-off of Nokia3 is not only in order, but almost certainly won’t happen
Gates is the chief proponent of Windows everywhere, the opposite of Windows on PCs only
Azure and Office365 are competitive with many of Microsoft’s own server products. It’s impressive that they have been as successful as they are, but there remain significant obstacles in getting full buy-in from Microsoft’s field and sales teams who make much more money off of on-premise licensing than they do from SaaS
However, what is most difficult of all is that pursuing the above strategy, while appropriate for the long-term health of the company, would almost certainly come with significant restructuring and thousands of layoffs. A profitable and growing Microsoft is a smaller Microsoft, and, in all likelihood, that’s not what Gates signed up for.4
So now we come to Satya Nadella. By all accounts he is a great guy, super sharp, and responsible for Azure, one of those foundational services I mentioned above. Still, he traces his recent success as head of Microsoft’s Enterprise and Cloud group mostly to the Enterprise part – aka on-premise server software – which is intimately tied to Microsoft’s current business model of PC + Office + server, not it’s necessary new model of any device + Office365 + Azure. Moreover, he’s inheriting the current leadership team of which he was recently a part, raising questions about just how much authority he can exert.
And, ever present, will be not just the specter but the very personage of Bill Gates, pirate, legend, and someone who probably should have stayed retired; as age is to basketball players, disruption is to technology companies, and Microsoft is on the wrong side of 30.
Two previous pieces on Stratechery that are worth reading in light of yesterday’s news:
Skating Towards the Goal, on Gates’ impact on Microsoft’s culture and the problem of having already achieved the goal of “A computer on every desk and in every home, running Microsoft software”
Services, Not Devices, which explains how Microsoft is better suited to horizontal opportunities than they are to vertical ones (I explored this further in this piece on the Nokia acquisition)
For what it’s worth, I hope I’m wrong. I have many friends at Microsoft, and it’s difficult to overstate how important the company is to the Seattle area. Moreover, I think it’s good for tech that they succeed and act as a counterweight to Google in particular.
And hopefully better product direction than that exhibited during the development of Windows Vista, née Longhorn ↩
Michael Jordan, the greatest basketball player in history, retired from the Chicago Bulls in 1998. However, in 2001, he returned to play two seasons with another team, the Washington Wizards. Jordan was old and frequently injured, and the seasons were mostly forgettable ↩
The best thing Steve Ballmer could have done for Microsoft would have been to make cuts last summer while restructuring the company, even if said reorganization was a bad idea. Instead he added another 30,000 employees while a lame duck in a deal that made no sense↩
One of the more annoying aspects of the late great PC area was how review sites treated Macs: for all intents and purposes, they were just another PC. Consider this CNET review of the 2007 MacBook Pro:1
The good: Updated CPUs and graphics without an updated price; LED-backlit display for better battery life; 802.11n support.
The bad: Minimal configuration options; only 90 days of toll-free technical support; still no media card reader.
PROS: Core 2 Duo upgrade completes the laptop line. Only one inch thick. Excellent performance. iSight Camera. More hard drive options. Front Row interface and remote.
CONS: DVD burner doesn’t come standard.
Conspicuous by its absence is OS X, and the fact that these were the only laptops that ran it. Sure, configuration options or media card readers may be important, but if I cared that my computer ran OS X then none of the cons – including price – mattered. Yet review after review, lost in their analysis of hardware speeds and feeds, ignored the fundamental differentiation provided by software, making their conclusions narrowly correct and broadly useless.
Sadly, things haven’t improved; indeed, as Apple has become one of the largest companies in the world, largely because of the iPhone, the obtuseness has spread to analysis. Consider this from Strategy Analytics (emphasis mine):
Samsung and Apple together accounted for almost half of all smartphones shipped worldwide in 2013. Large marketing budgets, extensive distribution channels and attractive product portfolios have enabled Samsung and Apple to maintain their grip on the smartphone industry. However, there is clearly now more competition coming from the second-tier smartphone brands. Huawei, LG and Lenovo each grew their smartphone shipments around two times faster than the global industry average and captured a combined 14 percent marketshare. Huawei is expanding swiftly in Europe, while LG’s Optimus range is proving popular in Latin America, and Lenovo’s Android models are selling at competitive price-points across China. Samsung and Apple will need to fight hard to hold off these and other hungry challengers during 2014.
The problem with lumping Samsung and Apple together, particularly in the last sentence, is that they face two markedly different challenges: saturation for Apple, and differentiation for Samsung. After all, only iPhones run iOS, while those “hungry challengers” run Android.
I wrote about these differences in one of the first articles I posted on Stratechery, Two Bears:
Bear Argument #1 is the imminent collapse of the iPhone in the face of significantly lower-cost alternatives…Bear Arguments #1 rests on the assumption that the iPhone is competing on hardware, and is therefore susceptible to lower-cost alternatives. However, the iPhone is not simply a device. Rather, it’s a ticket into an ecosystem…
Bear Argument #2 is the end of growth for the iPhone…In this case, the iPhone has saturated the high end, and while current iPhone users replace their iPhones, their overall numbers don’t increase significantly…
The iPhone faces little threat in the differentiated high-end of the market. Suggesting this market is limited in size is fair; counting the days until customers flee for cheap phones is silly.
That’s not to say that Bear Argument #1 is invalid; in fact, it’s the Bear Argument for Samsung. There is precious little that differentiates high-end Android from low-end Android…and not only are low-end devices increasingly “good enough,” they’re also impossibly cheap.
Indeed, over the last two weeks both Apple and Samsung have had worrisome earnings reports, but for very different reasons: namely, both bear arguments are coming true.
Samsung is being challenged by lower-cost competitors; the company’s average price per phone fell by $30 last year, and its share of >$400 phones slipped from 40 percent to 21 percent. This kept up Samsung’s volume – they now account for one in three smartphone sales – but the result was their first profit decline in nine quarters.
Apple had the exact opposite problem: the iPhone’s average selling price jumped from $577 to $636 quarter-over-quarter, and was only down $6 year-over year. Apple also increased its share of the >$400 market from 35 percent to 65 percent. Growth, though, was meager: a mere 7%, despite the addition of NTT DoCoMo and a much earlier China launch for the iPhones 5S and 5C as compared to the iPhone 5. According to Tim Cook, this was compounded by stricter upgrade policies amongst North American carriers.
There isn’t much that Apple can do. The market is clearly – and predictably – bifurcating between customers who care about differentiation and those who care about price; the 5S is dominating the former, the 5C was targeted at a middle ground that is disappearing, and Apple will never make a phone cheap enough for the latter.2
Still, growth primarily matters for its impact on AAPL the stock.3 The iPhone as a platform is in fine shape: the iPhone is increasing its dominance of high end customers, and its those high end customers who dominate usage. More importantly, they aren’t going anywhere. User experience is a sustainable differentiator in consumer markets, and any analysis that ignores iOS and Apple’s integrated approach as a differentiator is as useless as a Macbook review that ignores OS X.
Samsung is a different story. They have no meaningful software-based differentiation, and have seen the iPhone’s increased distribution eat into their high-end sales. A larger-screen iPhone would likely erode these sales further. Meanwhile, Samsung has to deal with Chinese Android-based manufacturers driving down prices not only in China, but, particularly now in the form of Lenovo, globally. Lenovo is crushing the traditional PC OEMs with both superior cost structures and superior R&D; at first glance there’s no reason to expect any different result in smartphones.
Still, Samsung has a much more integrated and impressive supply chain than any of the PC dinosaurs that Lenovo surpassed over the last decade, and they have a dominant position when it comes to distribution and carrier relationships especially, a complication that makes the smartphone market much different from the PC market. It will be fascinating to see the degree to which these strengths overcome Samsung’s lack of product-based differentiation.4
I just searched for a year at random, but long-time observers know these examples are hardly unique ↩
There is, though, one obvious area for growth: high end customers for whom the top priority is screen size. I have been banging the large-screen iPhone drum for quite some time now, likely because I live in Asia. As I noted a couple of weeks ago:
Anecdotally speaking, I don’t know a single person who doesn’t long for a larger iPhone, but I know plenty who switched to Android for this reason.
Remember, large-screen phones have significantly higher average selling prices; even if >4.5″ is a small part of the market, it’s all high-end, and if Apple wants iPhone growth it ought not leave any high-end stone unturned. ↩
The stock market is not an awards show; prices are about future earnings, and skepticism about Apple’s profit upside in light of the law of large numbers is warranted ↩
Samsung’s fate will be the true ultimatum on Stephen Elop’s decision to go with Windows Phone. I’ve argued strongly that Nokia should have gone with Android and leveraged their supply chain and carrier relationships. If Samsung continues to do well in the face of Lenovo and other Chinese manufacturers then that strengthens my case that Nokia could have succeeded as well ↩
It’s good to see one of the more tiresome myths of the last couple of years – that everyone is trying to be like Apple, just look at Google buying Motorola! – get put to bed once and for all.
Earlier today Google sold the remains of Motorola Mobility to Lenovo for $2.91 billion,1 closing the door on an expensive mistake that never made a lick of sense.
There’s not much to say on this point beyond what I wrote in Understanding Google:
The surest route to befuddlement in the tech industry is comparing a vertical player, like Apple, with a horizontal one, like Google.
Vertical players typically monetize through hardware, only serve a subset of users, and any services they provide are exclusive to their devices. Horizontal players, on the other hand, monetize through subscriptions or ads, and seek to serve all users across all devices.
Google certainly isn’t confused; they are 100% a horizontal player [footnote link]
Footnote: Well, except for that bizarre Motorola thing. My best guess is that the decision was ultimately a combination of misguided kingdom-building by Andy Rubin, patent panic, and delusions of Steve-Jobs-esque grandeur from Larry Page. Give them credit for treating it as a sunk cost (and by sunk cost, I don’t mean abandoned; rather, they are treating Motorola pretty rationally, not trying to justify $12 billion)
Credit to Google indeed: there will be a lot of deserved mockery over the next few days over the money that was lost, but the company has smartly limited the strategic damage and in some respects come out of the deal in a stronger position. Specifically:
While the Motorola patents are not worth nearly as much as it seems due to FRAND, Android is still in a much stronger position than 2012, particularly with this week’s cross-licensing patent deal with Samsung. Keep in mind that most of the Samsung patents are newer and likely more relevant than the Motorola ones. This deal was likely a win for Google.
Speaking of Samsung, Re/code reported this morning that the leading Android OEM will dial back its OS differentiation efforts in favor of a purer – and more Google-centric – Android experience. Another win for Google.
While Re/code attempted to paint the latter deal as some sort of intimidation on Google’s part, it seems obvious that the reason Google “won” both of these deals was Motorola: specifically, Google likely offered to get out of hardware if Samsung cross-licensed their patents and stopped pseudo-forking Android. Given Samsung’s dominant position in the Android ecosystem, the Motorola bargaining chip very well may have been worth several billion dollars.
And don’t sleep on Lenovo. I’ve long considered them the most likely global Samsung challenger. As they have demonstrated in PCs, they have the cost structure and market knowledge to compete and win in low margin hardware, and they now have the channel and brand to keep Samsung honest in North America – another win from Google’s perspective.2
All things considered, this deal deepens my appreciation for Google’s strategic acumen. Motorola was a mistake, but they didn’t chase sunk costs, and they made some rather tasty lemonade out of some very expensive lemons.
Which is actually overstating the price: only $660 million of that is cash, $750 million is Lenovo shares, and $1.5 billion is a 3-year promissory note that has a present value of ~$1.24 billion assuming a discount rate of 6.53%↩
One does wonder where this leaves HTC. I’ve long assumed that Lenovo would buy them for the same reason: channel and brand ↩
The iPad and other appliance-like devices have actually had the opposite effect [as compared to the iPhone] on computing. Many of the activities one used to do on a general-purpose personal computer are now done on machines better suited to the task at hand.
I think I got this precisely backwards.
If you start with the Mac (or PC – they’re interchangeable in this analysis), then the benefit of the iPad is all about its simplicity: touch and the limited nature of iOS make some computing activities easier and more approachable, especially for people like my mom. A Mac (or PC), meanwhile, can do everything an iPad can do and more (although it must bear the cost of complexity):
The problem with this thinking is the focus on “computing.” The things we humans wish to do are so much more varied: sing, play, dance, even, I suppose, make spreadsheets. It is a spectrum, of which traditional “compute” activities are only a small part:
Computing is only a small part of what people do
What makes the iPad so magical is that its simplicity – a piece of glass that becomes whatever app you choose to run – allows it to serve a much broader range of potential human activity than your typical Mac or PC.
The iPad can do many more things than a Mac, such as draw, make music, game, etc.
iPads are used for traditional computer activities, but they’re also used for gaming, for music-making, for drawing, even, apparently,1 for sumo wrestling. What is interesting, though, is that for almost all of these activities, the iPad is not the best possible tool.
Consider gaming:
There are dedicated devices that are superior for gaming, but an iPad is simpler and can do other things as well.
A dedicated device like a console will, at least according to some measures of performance, deliver a superior gaming experience (and a gaming PC, even better). But a console can only play games, and it is complex (and, again, a gaming PC even moreso). An iPad is simple, and it does other things as well.
Or music:
A real instrument is better for music, but it’s hard to learn and an iPad does other things.
An actual instrument is a superior music experience, but said instrument can only do one thing, and there is nothing simple about it. An iPad is infinitely more approachable, and it does other things as well.
It’s the exact same role the iPad plays with regards to the Mac or PC. A Mac or PC is a superior experience for traditional computing activities, at least according to traditional measurements like speed or efficiency, but an iPad is simpler and more approachable, and it does other things as well.
(This, of course, is why Macs aren’t going away. In fact, as Phil Schiller noted at the end of this great Macworld piece marking the Mac’s 30-year anniversary, the iPad has freed the Mac to focus even more on power users going forward.)
Ultimately, it is the iPad that is in fact general purpose. It does lots of things in an approachable way, albeit not as well as something that is built specifically for the task at hand. The Mac or PC, on the other hand, is a specialized device, best compared to the grand piano in the living room:2 unrivaled in the hands of a master, and increasingly ignored by everyone else.
Because I’ve been asked a million times…I like the idea of Your Verse, but the actual execution is a bit pretentious for my tastes ↩
Or yes, a truck. The point I’m trying to make is that iPads will be more widely used not just because they are simpler than Macs or PCs, but because they can actually do more. The car/truck analogy doesn’t quite capture that ↩
Facing competition from rivals offering smartphones with bigger screens, Apple Inc. is planning larger displays on a pair of iPhones due for release this year, people familiar with the situation said.
The people said Apple plans an iPhone model with a screen larger than 4½ inches measured diagonally, and a second version with a display bigger than 5 inches. Until now, Apple’s largest phone has been the 4-inch display on the iPhone 5…
The smaller of the two models is further along in development, and is being prepared for mass production, the people said. The larger-screen version is still in preliminary development, they said.
I’ve been certain a larger-screen iPhone was coming for well over a year now, and not because I know anything or anyone. Rather:
As the United States and Europe are increasingly saturated, the vast majority of smartphone growth will be in Asia
In Asia,1 the number one reason to not buy an iPhone (for those who can afford it) is screen size
The latter is a very real thing: TV viewing on your phone is very common,2 the sort of apps that are popular here3 work better on bigger screens, and everyone – including men – carry bags. Anecdotally speaking, I don’t know a single person who doesn’t long for a larger iPhone, but I know plenty who switched to Android for this reason.
Combine these two factors, and this “rumor”4 feels a lot more like “confirmation.”5
The problem with the old thin client model was the assumption that processing power was scarce. In fact, Moore’s Law and the rise of ARM has made the exact opposite the case – processing is abundant.
Data, on the other hand, is scarce – indeed, it is the scarcest resource in technology.
To be precise, I’m referring to personal data – my data, if you will – the opposite of “big data.” Were I to no longer have access to my various documents, pictures, emails, etc., I couldn’t simply walk into the store and pick up some more, and you couldn’t loan me yours. It’s precious, and it’s worthless, all at the same time.
Thus, over the last few years as the number of fat clients has multiplied – phones, tablets, along with traditional computers – the idea of a thin client with processing on the server seems positively quaint; however, in the context of our data, that is the exact model more and more of us are using: centralized data easily accessible to multiple “fat” devices distinguished by their user experience:
From “The (Alleged) 13-inch iPad and the Triumph of This Devices”. Click for the original article.
Dropbox’s approach to my most important data is much more in line with the value I ascribe to that data: it’s available everywhere.
Not so for iCloud: data is available only on Apple devices, and it’s not exactly clear how to get it out…The only coherent strategy for Apple is a walled-garden of sorts that protects their vertical business model. A services-centric company like Dropbox, on the other hand, ought to pursue a horizontal strategy predicated on maximizing the number of interconnects with the layers above and below.
Today, though, I’m not so sure; Dropbox’s model makes sense theoretically, but it ignores the messy reality of actually making money. After all, notably absent from my piece on Business Models for 2014 was consumer software-as-a-service. I’m increasingly convinced that, outside of in-app game purchases, consumers are unwilling to spend money on intangible software. That is likely why Dropbox has spent much of the last year pivoting away from consumers to the enterprise.
There are multiple reasons why the latter is a more attractive target for all software-as-a-service companies, especially those focused on data:
Consumers need to be convinced of the value of their data – Despite the fact that data is precious and unique to each consumer, the vast majority of consumers don’t know or don’t care. Backblaze, the online storage company, found that only 10 percent of people backup regularly; I would imagine anyone reading this who has tried to convince friends and family to buy a $70 drive for Time Machine or similar is nodding wearily. While backup is not the primary use case for Dropbox, the broader point remains: before Dropbox can get a consumer to pay for their data service, said consumer needs to value data in the first place.
The situation is the exact opposite in the enterprise; data is what ties the entire operation together, and it’s difficult to imagine any company anywhere that is not intently concerned with its data even before you consider the various regulations around data safekeeping. It is much easier to sell something to someone who already knows they need what you have on offer.
Consumers have multiple free options – As I noted above, Dropbox’s horizontal orientation aligns their incentives with my need to have my data available anywhere. Most consumers, though, are much less likely to consider such intricacies when deciding where to put their data. Instead, convenience usually wins, and it’s more convenient to use iCloud, SkyDrive, or Google Drive on Apple devices, Microsoft devices, and Google devices respectively.
Enterprises, on the other hand, will never choose one of the free services offered by platform providers: the licensing terms are usually unacceptable, there is no guarantee of uptime, security is a significant concern, there is no top-down control, and there is no customization. Thus, while there may be competition on price within the enterprise space, that price will not be zero. It should be obvious that this makes monetization easier.
Consumers are hard to market to – Reaching the sort of scale to profit from consumers requires converting millions; if you consider how few consumers even know their data is important, and the fewer still that are willing to pay, that means the top of your consumer marketing funnel must be exponentially larger. This then requires a huge amount of money for advertising as well as an advertising message that is sufficiently broad and non-specific to appeal to your addressable market.
This is another stark difference with the enterprise, where most marketing is still done to a small group of individuals in the senior leadership of the company, particularly the CIO. Influencing just one person can result in many thousands of users; more importantly, the ability to actually sit down and have a conversation lets you more effectively tailor your message and sell your product.
For consumers, collaboration is an edge case – Most of the data that matters to consumers is for use by them alone; that’s part of what makes the data so valuable on an individual basis, but it also means collaboration and general sharing of files is only necessary every now and then. This reduces the perceived utility of Dropbox, making it even more difficult to monetize (particularly with the freemium option sufficing for any collaboration needs that do come up).
In contrast, what is an enterprise if not a collection of people and the data they jointly create and consume? Data belongs to the corporation, and by definition requires collaboration. Collaboration features, then, are a necessity, and the quality and ease-of-use of them is of primary importance. Any service that excels in this area is meeting a real need (and, as I just noted, the direct contact entailed with enterprise sales lets you explain these features clearly).
Building a platform for consumers is incredibly difficult – The natural evolution of a service like Dropbox – and one that justifies such a high valuation – is to be a platform on which other apps and services depend. The trouble with building consumer platforms is twofold:
The vast number of consumers necessitates a broad-based general-use platform, even as different consumers have specific use cases. The only way to overcome this is with massive developer support and mindshare
Many potential partners are not incentivized to support your platform. For example, the device makers may have a competing service; other partners, like say Gmail (for contacts), have different business models; still other partners may have your business-model but view the consumers dollar as a zero sum game given their general unwillingness to pay anything at all
While building platforms for the enterprise is no walk in the park, both of these challenges are reduced:
Because you are making specific sells to specific customers, you have more latitude to build custom solutions that directly meet consumer needs, which may only entail a few specific partners for a payoff of many thousands of licenses
Potential partners are, just like your competitors, paid offerings as well. This better aligns incentives. This is particular the case of other SaaS companies, which often still see a benefit in promoting SaaS in general, leading to win-win offerings that expand the pie for all. For example, Salesforce has made cloud promotion a central part of their pitch; this makes them more amenable to partnering with a storage cloud solution (as opposed to, say Gmail contacts)
Again, platforms are hard, but the incentives and obstacles in the enterprise are reduced; thus, the likelihood of seizing the potential upside is increased.
This is what is driving Dropbox’s pivot. Well, this plus the reality that Dropbox, according to the WSJ, only had revenues of ~$200 million last year, hardly enough to justify their 2011 Series B valuation of $4 billion, much less this weekend’s Series C valuation of $10 billion. To wit, over the last several months Dropbox has:
Poached execs from Salesforce, VMWare, and Google to lead enterprise sales
Hired an enterprise sales team en masse (take a look at Dropbox’s LinkedIn profiles; it’s hard to find a sales exec with tenure greater than six months)
Relaunched Dropbox for Teams, which offered basic group management options, as Dropbox for Business which allowed dual business and personal accounts and slightly more fine-grained administrator control
Waiting in the wings, though, is the company most often compared to Dropbox: Box. Aaron Levie figured out a full seven years ago that enterprise was a far more attractive market than consumer. From a profile in the MIT Technology Review:1
By 2007, Box’s user base had doubled 20 times over and annual revenue was around $1 million. But Levie felt uneasy. The price of hard disks was falling 50 percent every 12 to 18 months. As online storage became a commodity, what would stop Apple, Google, or Microsoft from giving it to customers free? He noticed that the customers who stuck around longest weren’t storing MP3s or JPEGs but Word, Excel, and PDF files. In other words, business customers. Moreover, their colleagues would follow their lead, generating a steady stream of new sign-ups. Levie decided to ditch the fickle consumer market and focus on serving enterprises, companies with thousands of employees, which would be willing to pay for a storage service tailored to their needs. He set about adding the capabilities required by large businesses: search, security, and the ability to create and delete accounts, manage file access, and grant permission to view, edit, or delete.
In other words, what we have here is one of the more interesting business experiments we’ve ever seen: is it better to have established a firm foundation in the top-down enterprise market that actually matters – i.e. Box – or to have built tremendous goodwill and customer loyalty with actual users – i.e. Dropbox?
Looking back at the five factors I identified above:
Box has focused on enterprises – who value data – a full six years longer than Dropbox. This means they have a much more full-fledged offering when it comes to features like user permissions, centralized control, etc.
Box has long been focused on paid accounts, not freemium
Box has an experienced sales team that has been an integral part of the company for years; Dropbox is catching up in sheer numbers, but not in cultural or product competency
Box has only ever been concerned with competing with paid options; Dropbox has a legacy freemium business to be concerned with
Box has spent years building up its platform capabilities; Dropbox has a nice hold on small scale developers but little else
On the other hand, Dropbox has a significant lead in registered users: 200 million (at last report) versus 20 million for Box, and many of those users are intensely loyal.
Box itself raised a new round of financing late last year – $100 million at a $2 billion valuation. The question, then, is if I had $10 million, would I prefer to invest in Dropbox or Box?
The decision is a close one:
At the most recent valuations, $10 million will get me 0.1% of DropBox, or 0.5% of Box.
Dropbox has a lot of retrofitting to do; in the consumer space, security and downtime concerns are of relatively less importance. You may lose customers, but they’re not very valuable on an individual basis. In enterprise, though, your uptime is usually guaranteed contractually, and data integrity is a precondition. I am very curious what this means for Dropbox’s reliance on Amazon S3 and shared files
I’ve previously argued that The Consumerization of IT is Overstated; consumer and enterprise products are increasingly similar, but business models aren’t – and business models matter
Thus, if I had the $10 million, I’d invest in Box. Unfortunately, I don’t, which gives me the luxury of sitting back and observing which matters more: consumer headway in a market where enterprise pays, or enterprise capability – and business model – with a smaller base.
Excepting the patent and panic-driven Motorola deal, prior to yesterday’s acquisition of Nest for $3.2 billion, the previous largest deal Google’s history was DoubleClick for $3.1 billion 2006. Beyond the similar dollar figures, it’s a deal worth considering for what it says about Google then and now.
With the acquisition of DoubleClick, Google solidified its hold on online advertising, putting the final touches on one of the most successful business models in tech history. As Horace Dediu has documented, the more people use the Internet, the more money Google makes, and that’s a pretty good wave to be riding. In the succeeding eight years, Google has certainly undertaken any number of initiatives, but the core business of the company hasn’t changed. Still, this has given Google a remarkable amount of freedom to pursue all kinds of businesses, from phone operating systems to residential fiber, with the understanding that as long as it increased Internet penetration, it was good for the bottom line.
Still though, there have been ever-so-perceptible cracks in the armor. Revenue and profit from Google’s own sites have dramatically outpaced revenue and profit from Google AdSense sites, after previously moving in lockstep. Revenue-per-click continues to drop, driving Google to not only try to increase the number of clicks, but also to ramp up their data and profile efforts, in an attempt to increase the value-per-click. Moreover, a surprisingly large amount of Google’s ad revenue is driven by just a few adwords.
Beyond, that, there are two other longer-range concerns with Google’s business model:
The growth rate in Internet penetration is set to peak in 2016. Were Google’s revenue and profit continues to track Internet penetration, then those metrics would peak as well
A great number of Internet users today were not raised with computers; it’s fair to question how many of those clicking on Google ads falls in this group. As a new generation comes online, will ads continue to be effective at the scale Google needs them to be? I’m cautiously optimistic that advertising does not inevitably result in a terrible user experience, but there is certainly a point at which it does
In short, if you consider the three business models that are capable of being the foundation of multibillion-dollar businesses – consumer devices, ad-supported consumer services, and business software-as-a-service – Google had just about maximized their potential in the ad-supported consumer services model.
In my estimation, this deal is not about getting more data to support Google’s advertising model; rather, this is Google’s first true attempt to diversify its business, in this case into consumer devices.
Certainly Google has already done a lot of work in this area, from self-driving cars to Glass to any number of internal projects. But, especially in the consumer market, technology is not nearly enough. With Tony Fadell and his team, Google is getting some of the best product people on earth. Just as importantly – because product is not enough either – they are also getting an entire consumer operation, including customer support, channel expertise, retail partnerships, and all the other pieces that are critical to making a consumer device company successful.
That is why I fully believe Fadell and Google when they say Nest will remain its own operation, and am inclined to give them the benefit of the doubt with regards to Nest data. This deal is not about the old Google, but about what is next; it’s a second-leg for the Google stool, and it’s arriving just in time.
Some additional notes:
Apple: Not unexpectedly, many commenters are painting this as a loss for Apple, but I don’t think that’s true at all. I give a lot of credence to this report in Recode that Apple was never interested. Apple has a very simple business: they make personal computers, and they make accessories for computers. Certainly said computers are becoming ever more personal, and the accessories ever more smart, but they have never and, for the foreseeable future, will never be a diversified company. How many times does Tim Cook need to tell us that Apple focuses on just a few products? It’s funny how no one listens.
Microsoft: This transaction really has nothing to do with Microsoft, which I suppose is all that needs to be said, but it is interesting that this in fact makes Google a “Devices and Services” business. That, famously, is Microsoft’s new strategy, but, in classic Microsoft fashion, the devices they are focusing on are the ones that were groundbreaking half a decade ago, and their services even older.
Facebook: This transaction has even less to do with Facebook than with Microsoft, except to note that Facebook is where Google was when they acquired DoubleClick. They are just now figuring out how to make money, and will spend the next several years consolidating and growing that business. That’s fine: it’s the natural progression of any company. Maybe in eight years they’ll be buying what’s next.
Amazon: All of those devices need to be bought somewhere. Oh, and services need to be hosted.2 Jeff Bezos is a smart dude.
Perhaps the greatest continuing disconnect between technologists and normals is the value ascribed to software. As Marc Andreesen famously declared, “Software is eating the world,” and while that is absolutely true, software, especially in the consumer space, is not eating value, at least not directly. In fact, if 2013 taught us anything, it’s that the value consumers place on software is lower than ever.
This phenomenon was seen most clearly in the app store economy, where paid downloads plummeted in popularity. Multiple developers have written about how increasingly difficult it is to make money on the store, and despair about the relentless march to free (with in-app purchase). I myself have joined in, excoriating Apple for not doing more to help developers create sustainable business models in the app store. Ultimately, though, the removal of friction from the software buying process has – just as it did for music and other media – reduced or removed the willingness of many consumers to pay.
It’s telling that software and music share a common heritage: round, shiny pieces of plastic in a shrink-wrapped case. While the very idea of driving to a store and buying a physical object already seems absurd, it seems it was the physicality of that CD – and disks and tapes before that – that drove customer willingness-to-pay. Consumers may not understand at a technical level what is happening when they download an app or a song, but they seem to implicitly know that they are simply copying bits, a process which has a marginal cost of zero.
As I wrote in Open Source Apps, over time the price of a product moves to its marginal cost, and if the marginal cost is zero, that means free is inevitable.
As competitors enter the market, the price moves towards the marginal cost. In the case of software, that is $0.
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.
On the flipside, though, tangible products, which by definition have marginal costs of greater than $0 – continue to be valued by customers. No one expects a free microwave, or car, or even a candy bar. Consumers understand that making, packaging, and shipping such products costs money, and there is no compunction to spending money for that proverbial latte that is more than an app.
This is critical to understand while thinking about consumer business models: consumers pay money for tangible goods; they don’t for virtual goods (in-app purchases for games is a glaring exception here). It then follows that the two primary ways to make money in the consumer market is through 1) the sale of physical devices and 2) advertising (usually for physical goods). Ultimately, though, success in either area is dependent on software. It really is eating everything.
Physical goods.
Perhaps the classic children’s gift is the remote-controlled car. Who doesn’t have memories of eagerly eyeing the Christmas lineup at your local Radio Shack, eagerly opening your presents, scrounging for batteries, and finally driving your car like the maniac you are. A classic physical device, sold for cash.
It’s this context that makes sense of Apple’s odd opening to last year’s WWDC. The only app demo was of Anki, today’s version of the remote controlled car. Of course these cars are nothing like those pieces of junk at Radio Shack: Anki cars have artificial intelligence, the parameters of which are set with an app. The app, obviously, is free, but the value of the software within the app is realized through the $199 price of Anki drive.
This is one of the primary ways that software will be monetized going forward: hardware sold at a significant margin that is justified by the differentiation provided by software. In fact, I just described the business model of Apple itself. The physical components of a MacBook Pro or iPad have a marginal cost that is significantly lower than their retail prices; the margin is provided by software.
Another great example – and particularly relevant for this blog and this topic on this blog – is Paper. Last year I decried the fact that Paper couldn’t build a sustainable business on the app store:
With a small amount of seed funding, the original five employees set out to build Paper, the best place to capture your ideas. After launching a year later, they began to reap the rewards through in-app purchases. They kept improving the app, and came out with a significant update in October – the Mixer – for $1.99.
And then they realized that they were five people living in New York City without an obvious route to sustainable revenue.
Instead they are building physical devices: while they may have had limited success charging $4.99 for an in-app purchase, they are presumably having much more success charging $59.99 – including a substantial profit margin I’m sure – for a physical good, the Pencil.
Advertising
The size of the consumer market in technology is greater than it has ever been before. Not only do more people have access to computing devices, but, thanks to mobile, a much greater percentage of a person’s time is spent with computing devices. And, crucially, there is one industry that values consumer time and attention far more than consumers themselves do: advertising. This reality is at the root of Facebook’s resurgence over the last year, and for the initial bullishness on Twitter’s IPO.
The continued strength of the advertising model – and the data collection and analysis that goes along with this – is the flipside of consumers’ unwillingness to pay for software: consumers demand great products such as Google search, Facebook, or Twitter, and have demonstrated clearly that they will tolerate advertising in exchange for getting such experiences for free.
In fact, I think one of the biggest misconceptions in technology is that companies like Google or Facebook will inevitably irretrievably damage their products because their true customer is the advertiser. To be sure, there is a cost from advertising – this recent WSJ profile of Facebook said mobile advertising reduced activity by 2% – but that is necessarily countered by a focus on improving a product more rapidly than advertising degrades it.
Consider the incentives:
Company A competes in a marketplace dominated by paid products; the fact you have to pay to switch builds a bit of a moat around their products, reducing the incentive to improve them rapidly
Company B competes in a marketplace dominated by ad-supported free products; switching costs are minimal, creating huge incentives to ensure the impact of advertising is much less than the increase in value of the product
In short, I am not at all certain that advertising breeds poor products; it is possible it does just the opposite. What I am certain is that advertising as a way to monetize consumer-based software is here to stay, and that any service that can capture an outsized amount of consumer attention – e.g. Snapchat – will be very valuable.
Phones are the clearest manifestation of this trend; the iPhone, Android, and even Windows Phone are first and foremost consumer devices; it’s corporate-focused BlackBerry that is all but finished.
But while this trend may be true when it comes to the technology itself, the differences in business models and go-to-market strategies seems more distinct than ever.
Start with advertising: no business is going to rely on an advertising-based service for critical line-of-business needs. Beyond the lack of professionalism, data security concerns makes any consumers service a non-starter.
Devices, though, are becoming just as distasteful, especially for publicly traded companies. Devices such as servers are a capital expense, and have a significant impact on the denominator of the most important ratios used to evaluate companies: the return on invested capital.
Instead, it is businesses who are increasingly willing to do the exact opposite of consumers and pay for non-tangible goods in the form of software-as-a-service:
Software-as-a-service, as noted, has a positive impact on a company’s financial structure, and means more stable and predictable operating costs
Businesses still typically have centralized purchasing which responds well to productivity arguments. making it easier for a SaaS company to articulate the value of software. This is a marked contrast to consumers who can only be reached through blunt mass-market advertising. It also means that successful SaaS companies will have well-developed sales teams
Businesses often require customization or have specific feature requests, and are willing to pay for it. Successful companies balance responsiveness with a clear vision about where their customers ought to go; the fact SaaS is cloud-based and thus easily and quickly iterated upon makes this balancing act much more possible than on-premise software with multi-year upgrade cycles
That said, some of the dynamics that apply to consumer-focused advertising-based businesses apply to SaaS as well: specifically, switching costs are lower, and employee knowledge of alternatives is likely to be greater. This will continue to drive a much higher standard for business software, magnifying the challenge faced by traditional vendors who have focused on maximizing lockin and multi-year engagements.
To be sure, other business models will continue to exist, including paid downloads, consumer-focused software-as-a-service, and hardware for businesses. Moreover, there are exception to this trend: the entire in-app purchase gaming segment, for example, or Evernote, which seems to be finding success as a predominantly consumer-oriented SaaS offering. However, going forward, I expect companies built with such models to be increasingly specialized and smaller-sized, and those which are already large – such as Dropbox – to continue pivoting to the enterprise.
PCs just suffered their worse quarter ever. From the WSJ:
World-wide PC shipments fell 10% last year, research firms Gartner Inc. and IDC said Thursday, the worst-ever sales slump for the industry. Both companies have been tracking personal computer sales since the 1980s. Computer makers have been hurt as consumers and businesses spend more time on smartphones and tablets, and are slower to replace aging PCs.
Here are the last 10 years of PC Sales from IDC (thanks to Charles Arthur, who wrote a great column today about PC OEMs, for the full set of numbers):
The WSJ – and prevailing wisdom – blames two factors for the decline of PCs: PCs have become “good enough,” lengthening the replacement cycle, and more and more time is being spent on tablets and other appliance-like devices.
However, I don’t think these factors are independent; it’s not just that tablets occupy more of a user’s time, but that by doing so they make any performance issues on one’s PC less pressing simply because you use it less. To put it another way, users are likely to have a higher standard for their primary computing device than they are a secondary one; as PCs become secondary devices for more and more people the standard for “good enough” becomes lower and lower.
Looking at year-over-year growth certainly suggests that tablets are the bigger factor – note the step decrease in growth in 2010, the year the iPad was released:1
This was particularly worrisome for Microsoft; the only way that Microsoft makes money (in the consumer market) is through users buying new computers and the associated licenses (this is why Bing’s failure was so critical; by failing to build profitable online services, Microsoft has no way of monetizing consumers over time). This means that people using Windows are in effect worthless to Microsoft; they need people to buy Windows, which usually means buying a new computer.
This was the context for Windows 8, which was meant to address both of the problems facing PCs:
By making touch a central part of the interface, customers would find that their current non-touch PCs were not good enough, and thus be motivated to buy new hardware (and new Windows licenses)
By having touch and an app store, customers would spend more time on their PCs, once again making them the primary device and raising the expectation for performance, reducing the upgrade cycle
However, the exact opposite happened. Look again at the year-over-year growth chart: there is the big change I alluded to in 2010, and another big change in 2012, when Windows 8 came out. It seems clear that Windows 8 made things worse.
It’s not simply that the additional performance is not valued by your customers; rather, the bigger problem is that the additional complexity that necessarily accompanies said performance is actively harmful to your customer’s user experience. Your product is not only becoming more expensive, but it’s actually becoming worse from your customer’s point-of-view.
In other words, instead of alleviating the problems facing PCs – no reason to buy – Windows 8’s increased complexity added a reason not to buy. That was certainly the case in my family: in early 2013, when my father asked me for advice on a Windows computer,2 I found myself advising him to seek out Windows 7.3 Were he to have had a suitable computer, I likely would have advised him to do nothing at all.
It’s difficult to see where Microsoft goes from here; contrary to what you might expect, there is still minimal overlap between Windows 8 and Windows Phone, meaning apps made for one are incompatible with the other.4 Abandoning either means effectively starting from zero in that respective form factor – and pissing off a lot of partners. Yet there’s little question in my mind that the touch environment is hastening the decline of PCs suited for the Windows desktop, even as the desktop ruins what is honestly a rather delightful tablet experience.
Microsoft’s trump card remains Office,5 a product with power that remains under-appreciated by most in Silicon Valley (e.g. my dad’s job). However, the complexities of Windows are rapidly dragging Office down; one of the most critical decisions facing the next CEO6 is whether or not to unburden Office from the Windows strategy tax and leave Windows to figure it out on its own.
The plummet in 2008-9 was due to the Great Recession; the peak in 2009-10 was pent-up demand from said recession ↩
Of course Office is itself partially to blame for the failure of Windows RT; it was because Office failed to make a Metro version that the desktop environment even existed ↩
The sort of CEO Microsoft needs will demand Gates and Ballmer leave the board; by all accounts this isn’t going to happen. Thus, stalemate ↩
