Like most, I was surprised to read on Monday that Google is paying $12.5 billion to purchase Motorola Mobility (MMI). Although Google is clearly looking to buy patents, $12.5 billion is a huge amount for a group of patents that is of little use in Google’s primary lawsuit and hasn’t deterred others from suing MMI. Furthermore, MMI comes “encumbered” with a giant mobile device manufacturing business that doesn’t make money. A takeover of MMI will be difficult, awkward, and expensive.
By all accounts, Android is thriving. Android activations have grown 244% YOY, from 160,000/day in June 2010 to 550,000/day in July 2011. Android’s share of the US installed smartphone base has increased from 13% in May 2010 to 40% in June 2011. Meanwhile, the iPhone has “stagnated” at around 24–27% of the US installed base. Android appears almost unstoppable, potential patent licensing fees notwithstanding, so why would Google jeopardize everything by jumping into direct competition with its own OEMs?
My suspicion after seeing this Android carrier share data release by Chitika is that Google is dissatisfied with Android’s market performance and is concerned about its US prospects once the iPhone is available on Sprint and T-Mobile. Given the statistics above, it seems shocking that Google could be dissatisfied with Android’s market performance (as opposed to its IP liability), but I’ll lay out the facts below.
The First Warning Sign: Low ASPs
It first occurred to me that Google might be dissatisfied with Android’s market performance when MMI released its Q2 2011 results. Unsurprisingly, MMI reported strong YOY growth (63%) in smartphone sales. However, what surprised me was that their implied smartphone average selling price (ASP) dropped by over $100, from $493 to $384. (To figure this out you need to make assumptions about feature phone and Xoom ASPs. Based on observable market prices I assumed a feature phone ASP of $70 and a Xoom ASP of $700, but the overall conclusion is not sensitive to reasonable deviations in these assumptions.) This implies that either MMI’s product mix has shifted towards selling lower-end Android phones, or that MMI has had to slash prices to clear inventory. Either way it implies that they are not doing well in the high-end smartphone market. HTC – arguably the most successful of Android OEMs – reported a similar pattern in its Q2 2011 results: average revenue per phone sold dropped by 16% YOY. A large share of Android’s phenomenal success is coming in the mid-to-low end of the market. But what’s wrong with that – isn’t that where most of the potential sales are?
The other oddity in MMI’s earnings report was its apparent weakness in North America. In Q2 2010, 66% ($1.14 billion) of MMI’s revenue came from North America. Last quarter, only 43% ($1.04 billion) of MMI’s revenue came from North America. MMI’s North American revenue actually declined by 10% during a time when overall Android shipments more than tripled. This decline is even worse than it looks when you consider that the Xoom – a North American-focused product – accounted for approximately $300 million of revenue last quarter. North American phone revenue must have declined by 20–30%. MMI’s weakness in North America, however, was masked by significant growth in Latin America, China, and the rest of Asia.
The Real Concern: Weakness on Verizon
Because of how each company makes its money, Google cares much more about the US market than Apple does. Apple makes approximately the same amount of profit on an iPhone sold in China as it does on an iPhone sold in the US. There’s probably a little more profit to be made from iTunes and App Store sales on US iPhones than on Chinese iPhones, but it’s rounding error in the average profit per iPhone. Google, in contrast, makes money selling ads on Android phones (and iPhones!). To a first approximation, an average middle-class Chinese consumer has zero value to Google’s advertisers. Furthermore, Chinese Android phones don’t even ship with Google as the default search engine, which is not surprising given that Google has given up on the Chinese search market. I have little doubt that Google would rather sell 1 Android phone in the US than sell 10 Android phones in China. Hence, while US sales make up only a small fraction of the 550,000 daily Android activations (a generous guess would be 20%), they are very important to Google.
I want to look at Android’s success in the US market from several different angles. First, consider net subscriber additions (as measured by ComScore) to the two leading smartphone platforms, Android and iPhone:
Android clearly has the momentum, averaging well over twice as many net subscriber additions per month as iPhone. While iPhone net additions rose in February 2011 with the release of the Verizon iPhone, Android net additions have not declined much in response. This figure is unflattering to the iPhone because a large share of US iPhone sales are replacements of existing iPhones and thus do not qualify as net subscriber additions. Few Android sales are replacements of existing Android phones since the vast majority of Android sales have occurred within the last 12 months (the minimum window in which a subscriber can qualify for a new phone subsidy). Nevertheless, based on this figure, it’s hard to see how Google could be concerned about Android’s US market performance.
(Data note: ComScore has not yet measured subscriber growth for 3 month periods centered on July 1 or August 1. In this chart and subsequent charts I have stacked the deck in Android’s favor by assuming that growth in July and August was 10% above its recent average of 2.1 million net additions per month.)
Now combine the ComScore data with the Chitika data on Android carrier share, measured in June 2010, January 2011, March 2011, and August 2011. (Data note: Intermediate months are interpolated. This affects the accuracy of intermediate month figures but does not affect the overall trend.) This allows us to compute subscriber numbers by platform and carrier. Of particular interest is the number of net subscriber additions for each platform on Verizon:
As soon as I saw these numbers, the expensive MMI purchase made much more sense to me. A single 14-month-old iPhone model, priced at $199 or above, has stolen most of Android’s subscriber growth on Verizon. And unlike Apple on AT&T, Google can’t take solace in large sales of devices to existing subscribers or appeal to saturation of smartphones among Verizon subscribers (50% of AT&T postpaid subscribers own smartphones, while only 36% of Verizon postpaid subscribers own smartphones).
It gets worse. Since overall Android growth has not stalled, it must be the case that other carriers are picking up the slack for Verizon. Who are these other carriers? This figure plots net Android additions for four groups of carriers: Verizon, Sprint/T-Mobile, AT&T, and prepaid carriers:
Two carriers took up the slack for Verizon’s declining net additions. One was AT&T – the arrival of top-end phones like the Atrix 4G and the Inspire 4G have finally moved Android’s AT&T share from “nothing” to “small”. But half of the slack was taken up by growth in net additions at prepaid carriers. Prepaid customers are of little value to carriers, and they are unlikely to be coveted by advertisers or developers either. Hence, like emerging market customers, they are of little value to Google.
The Nightmare Scenario
If I were a slightly paranoid executive at Google, I would worry about the following hypothetical scenario circa December 2011:
- Apple releases a new iPhone 5 this fall on all major US carriers. It also releases an “iPhone 4 Lite” on most or all carriers, possibly priced as low as $49.
- Verizon iPhone net additions increase by 50% in response to the new hardware and price points (history suggests this could be conservative – AT&T iPhone net additions more than tripled in the quarter following the iPhone 4 GSM release).
- Sprint + T-Mobile iPhone net additions follow a similar pattern to Verizon iPhone net additions (Verizon has almost the exact same number of Android subscribers as a combined Sprint + T-Mobile).
- Verizon Android net additions continue to stay depressed in light of the new iPhones, and Sprint + T-Mobile Android net additions follow the same pattern that happened at Verizon.
- AT&T Android net additions decline slightly from current levels in response to the new iPhones. However, AT&T does not gain any new iPhone subscribers as it is already heavily saturated with iPhones.
- Prepaid Android net additions remain strong, but I (the Google executive) don’t care much about those.
That scenario, which may not happen but is certainly plausible, looks like this (focusing on postpaid customers only):
Suddenly the momentum shifts. This momentum shift would be particularly bad because the iPhone has other advantages that can compound any loss in Android momentum. It has what most consider to be a much more successful App Store. It leverages an ecosystem that also includes the iPod Touch and the wildly successful iPad. Ceding most of the mid-to-high range phone market to iOS could be a serious blow to Android.
Understanding that, I might not want to leave Android’s fate in the hands of OEMs that I can’t control. If I were someone prone to rash decisions or bet-the-company moves, I might pull the trigger and purchase my own OEM to try to beat Apple at its own game.