Android: Winning the Smartphone Battle, But Losing the Mobile OS War

Earlier this week I received a long-awaited text message from Verizon Wireless notifying me of a credit I had available towards a new phone if I renewed my contract for another two years. After 9 ½ years of BlackBerry devices (my first BlackBerry actually ran on the Mobitex network, for the old-school mobile-types out there) I’m ready for a change. With a relatively paltry selection of native apps and a mobile web surfing experience reminiscent of dial-up internet access circa 2000 the question I’m left with is which smartphone do I go with- one from Android or Apple?

With the Android-based Motorola Bionic delayed until the second half of the year and rumors of the iPhone 5 shipping anywhere between September and the next year, the immediate decision seems to come down to whether I should get the 4G LTE network-enabled HTC Thunderbolt or iPhone 4. But is this the real question I should be asking myself?

The speed of Android’s rise to prominence in the U.S. smartphone market has been nothing short of amazing, growing from a 9% market share in February 2010 to 33% in February 2011, vaulting Android’s operating system from 4th to 1st place in the process according to comScore. Over that same period of time Apple’s U.S. smartphone market share has stayed flat at 25%. This had led to people like venture capitalist Fred Wilson of Union Square Ventures to suggest that developers should build for the Android operating system first.

What Fred’s analysis, this market share data and my question fail to address though is the broader market dynamics of mobile. The battle everyone is focusing on is Android versus iOS smartphones- and why not? With 70% of the U.S. still using feature phones, according to the same comScore data, the market opportunity for smartphones remains massive. Even so, the war between Apple and Google is actually taking place at a much broader level, as decisions made by consumers like myself and developers alike will decide who the eventual market leader will be for the entire mobile operating system (OS) market- not just smartphones.

While Android might be winning the smartphone market share battle, it’s at the mobile OS level that iOS holds the advantage over Android. Google’s primary market for distributing its mobile OS is the smartphone via HTC, Motorola, Samsung and other handset manufacturers. Apple on the other hand distributes iOS across three markets through its own devices- handheld entertainment devices (via the iPod Touch), smartphones (iPhone) and tablets (iPad). Because of this Apple’s outlook is much broader in scope- to get its other iOS devices into the hands of the 80% of the market (70% of the feature phone users in the U.S. plus the 1/3rd of the smartphone market not on Android or Apple smartphone) not using an Android or iOS smartphone. By getting consumers to purchase an iPad or iPod Touch, Apple can create a barrier to entry for Google through high switching costs.

With every app install, especially paid ones and those that can be used across device types, consumers increase their switching costs for leaving Apple’s ecosystem. So when the time comes for iPad and iPod owners to upgrade their mobile phones, the iPhone is the natural choice since these users are already familiar with Apple’s App Store and iOS user experience. With the iPod’s market share pegged at 70% of the digital music market last year according to NPD and iPad’s at 85% of the tablet market in 2010 according to ABI Research, Apple has a huge advantage over Google in getting consumers onto its mobile OS platform through these types of devices. As iPod sales begin to decline though, the growth in iPad sales will be the key complimentary product in Apple’s effort to gain market share in the smartphone market.

According to a different study released by comScore earlier this week, there is evidence to corroborate iOS’ network effect for Apple in the U.S. iOS’ reach is 59% greater than that of Android when you combine iPad, iPhone and iPod users. This translates into approximately 38 million iOS users overall in the U.S. versus nearly 24 million Android users. More importantly though, in looking at iPad sales specifically, BlackBerry users account for the second highest percentage of iPad owners, behind iPhone customers, followed closely by Samsung and LG. This represents a great opportunity for Apple to convert these users into iPhone customers once their contracts are up or they ready to switch to an advanced smartphone. Update: comScore just released a similar study for the European market showing Apple’s reach being 116% greater than Android in France, Germany, Italy Spain and the UK- albeit on a smaller user base (29 million consumers) than in the U.S. As it relates to iPad adoption, Nokia users closely follow iPhone users in iPad ownership, providing Apple with a huge opportunity to take market share from the largest mobile handset manufacturer in the world.

So how can Android better compete with iOS at the mobile OS level?

  • First, Google needs to nail down agreements with the music industry’s four main record labels in order to launch its cloud-based music competitor to iTunes. This will allow manufacturers to create devices that can finally compete with the iPod and eliminate the biggest feature advantage of the iOS platform.
  • Second, Android tablets need to be synched with the smartphone’s OS platform. The Motorola XOOM, which launched with much fanfare towards the end of February as the first real competitive threat to the iPad (after winning Best of Show at CES in January), seems to have come up short. Sales of the tablet have been estimated at 100,000 devices in its first 5 weeks on the market compared to the iPad which sold 300,000 devices its very first day and nearly 5 million devices in the just announced second quarter. By running a newer and completely different version of Android than its smartphone siblings (Honeycomb 3.0 versus Android 2.0 thru 2.3.3) the device hasn’t been able to leverage apps from the smartphone Android Marketplace. According to Apple’s COO Tim Cook a fragmented ecosystem where Android tablets have less than 100 apps to choose from while iPad customers have 65,000. Without a cohesive OS platform across device types, Android will lack the switching costs afforded to Apple’s OS ecosystem.

For developers, the 189 million cumulative iOS devices sold through the end of March 2011 represents a huge market opportunity. Add in ease of monetization and payment mechanisms in addition to a formal app discovery process that is still lacking in Android’s marketplace, you can see why companies like Color and Instagram chose to launch in the iOS App Store first and why there continues to be more apps available for iOS than Android even though Apple has a more stringent app vetting process.

As for myself, the decision was easy once I took a step back and looked at the broader mobile OS ecosystem options. Even though I already owned an iPod Touch, I’ve decided to go with iOS primarily because I was planning on picking up a new iPad in the first place. So by default, the iPhone it is for me. With three different types of devices being tied to iOS when it’s all said and done I will be Apple’s ideal customer. The only question I have left? Do I wait for the white iPhone.

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How the Mobile OS Wars Will Be Won

The future of the mobile industry is pretty clear- it’s all about data. Data revenues have allowed U.S. carriers to keep subscriber ARPU’s relatively stable in the face of 30% declines in voice revenues over the past five years. Look no further than Verizon Wireless’ recent announcement to allow unlimited Skype-to-Skype voice calls over its 3G network to see the future revenue prospects of voice, now a commodity service.

Data revenues, in contrast, are expected to continue their explosive growth, more than doubling by 2013 according to a recent Telecommunications Industry Association report. It’s no coincidence that over the same period smartphone sales are projected to account for more than 40% of all wireless devices sold domestically as the underlying mobile operating systems on these devices are providing the necessary functionality and services that are enabling greater data consumption by mobile subscribers.

At the recently concluded Mobile World Congress, Microsoft made the mobile OS market a lot more interesting with its unveiling of Windows Phone 7 Series, a completely rethought and overhauled, mobile operating system. Having met with glowing first impressions, the largest software company in the world has positioned itself to compete across the entire smartphone OS spectrum- from Research in Motion’s productivity devices to mass market offerings leveraging Google’s Android platform to feature-rich iPhones from Apple. However, without the ability for manufacturers to upgrade their handsets from Microsoft’s current operating system, Windows Mobile 6.x, to Windows Phone 7, Microsoft will need to build adoption for its new platform from scratch. Microsoft, like the entire mobile OS market, has to successfully address three key relationships in the mobile ecosystem, and not just build a great technology platform, in order to win market share.

1. Device manufacturer access. To get an operating system into consumer hands, most mobile software providers need to partner with device manufacturers. Google has attempted to remove any potential barrier for these OEMs to adopt its Android platform by making it free to use, open source and fully customizable. Microsoft on the other hand is continuing with its licensing model for the Windows Phone 7 operating system as well as imposing stringent hardware requirements on its device partners going forward.

It is these requirements, in conjunction with recent events, that make it unlikely that HTC will continue as Microsoft’s primary device partner. First, HTC, which built the Nexus One for Google, just launched its own version of the Android device at the Mobile World Congress. Dubbed the Desire, this handset incorporates HTC’s Sense, a design experience the company is implementing across all of its future devices, regardless of the underlying operating system, which could run afoul of Microsoft’s new partner standards. Secondly, HTC’s soon to launch HD2, the most feature-rich smartphone running the Windows Mobile 6.5 operating system, does not meet Microsoft’s Windows Phone 7 requirements to qualify for an OS upgrade.  Considering the close relationship HTC fostered with Google in developing the Nexus One, Microsoft would be prudent to look elsewhere for access to consumers.

Fortunately for Microsoft, LG, the third largest mobile handset manufacturer in the world, and second in the U.S., has announced its intention to be the first OEM to launch a Windows Phone 7 handset this fall. This could result in faster adoption for Microsoft’s new mobile OS especially if other OEMs decide to diversify their operating system portfolio due to Google’s directly competitive Nexus One mobile offering.

Unlike Google and Microsoft, Apple and Research In Motion view their primary businesses as being mobile. Due to this  both have vertically integrated the development of handsets and the underlying operating system. This has enabled both companies to enjoy a more direct relationship with consumers and helps ensure a more consistent user experience across their respective handsets. It’s no surprise that combined, Apple and RIM control two-thirds of the U.S. smartphone market.

2. Retail outlet distribution. As Google learned in launching the Nexus One device, working with the network carrier on distribution and marketing is essential for driving sales and adoption. Google’s internet-only, direct-to-consumer approach to selling the Nexus One on T-Mobile’s network resulted in less than 100,000 of these devices being sold in the first month. Contrast that with the launch of Motorola’s Android-based Droid which resulted in over 500,000 units being sold in its initial month. The Droid’s relative success to the Nexus One can be attributed to the coordinated support from Verizon Wireless which (a) has the largest subscriber base and arguably the best wireless network in the U.S. (b) provided distribution for the device through its retail outlets and (c) was backed by a $100 million marketing campaign.

More than any other mobile OS provider, Research In Motion has benefitted from its wireless carrier relationships. With BlackBerry devices available on every major carrier’s network in the U.S., and thus distribution provided through every wireless retail outlet imaginable, RIM has reached over 40% share of the domestic smartphone market.

Apple on the other hand has succeeded in spite of its exclusive relationship with AT&T Mobility in the U.S., primarily because it revolutionized the smartphone experience with the iPhone, but also because it has been able to drive distribution for its device through its own Apple stores.

3. Developer retention. While device manufacturers and wireless carriers are the critical factors in driving smartphone OS adoption, the iPhone exemplifies why developers are the key to retention. In spite of all the grief and anger directed at AT&T by iPhone users, most customers are unwilling to switch wireless carriers due to the personalization functionality provided by the iPhone through its app store. Even with Apple’s frustrating application approval process, developers continue to focus on building for the iPhone platform because it offers the most lucrative revenue opportunity, according to interviews conducted by Gizmodo at the Mobile World Congress, with interest in Android a distant second but growing due to its potential reach now that 60,000 Android-enabled devices are shipping daily.

Microsoft will need to create the same enthusiasm with developers for its new operating system in order to get these individuals to allocate some of their development time and efforts to learn yet another platform. Unfortunately Microsoft lost a chance to jumpstart its efforts by not having a path for them to port their current Windows Mobile apps to Windows Phone 7.

…and the winner is? I agree with Accel Partner’s Richard Wong that fragmentation in the mobile space is here to stay due to technology but also because of varying business models.

Domestically, Apple will determine how the mobile OS market plays out. If it were to end its exclusive arrangement with AT&T and go with a multi-carrier approach, which has proven to be successful from a market share and financial perspective overseas, Apple would control the most lucrative smartphone market in the world due to its strong relationships within the mobile ecosystem versus its competitors.

Worldwide, Gartner Inc.’s prediction that Google’s Android platform will surpass BlackBerry, the iPhone and Windows Mobile in market share in 2012 is fairly safe due to Google’s approach and the economics of its operating system. Google’s interests in the mobile space are squarely focused on search and location-based advertising. As such, giving away its platform makes complete sense. The biggest risk Google faces is getting into its own way by pushing corporate agendas that come at the expense of partner relationships. Developing its own mobile handset, acting like a telecom company by acquiring wireless spectrum or building its own broadband network, and allowing the fragmentation of the Android operating system are all examples of how Google could quickly lose favor with each of the three key relationships in the mobile ecosystem.

Through sheer size alone Microsoft should be able to rebuild most of the market share it has captured with previous iterations of its mobile operating system with Windows Phone 7, but not to the point that will make it a market leader. Microsoft’s continued reliance on a licensing model for its mobile OS and restrictive design parameters will hurt adoption as it competes against a free and open Android platform. While integrating the Xbox experience directly into the Windows Phone 7′s capabilities might be enough to convert some iPhone gaming enthusiasts, Microsoft’s Zune is a distant second to iTunes’ content portfolio, making it difficult to compete with Apple’s overall smartphone offering.

With Microsoft committing $1 billion to develop its new mobile operating system, Research In Motion faces the greatest market share risk. Not only is an acquisition of RIM by Microsoft highly unlikely now, but Windows Phone 7 Series OS is best positioned to compete with BlackBerry’s biggest strength- mobile enterprise email. By bringing Outlook to its mobile operating system, Microsoft can woo traditional BlackBerry users with native email capabilities and additional functionality through its Office productivity suite. Research In Motion has not only taken a preemptive strike against Microsoft but Google as well, which has integrated Google Apps into Android devices, by releasing a free version of its enterprise server for small businesses. With a relatively small application store, RIM will have an even greater difficulty in retaining its mobile OS market share lead in the U.S. over the next few years.

Whatever the outcome the consumer wins, as the competition will continue to breed innovation and enable smartphones to further evolve from productivity devices into personalized mobile experiences- courtesy of the mobile operating system.

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Even with Android, and now Nexus One, Google Still has Apple Envy

While the media has enjoyed positioning the recent launch of Google’s Android-based Nexus One “superphone” manufactured by HTC as a direct competitive threat to Apple’s iPhone, I agree with Bill Gurley of Benchmark Capital that this is the wrong question to try to answer as Apple and Google are taking very different approaches to the mobile market. Apple, as in the personal computer market, has focused on developing the most well designed, highest grossing margin, products they can imagine at the expense of market share. Google on the other hand, by open-sourcing the Android operating system to handset and device manufacturers for free, is aiming to become the most widely used mobile operating system at the expense of Microsoft’s Windows Mobile and, to a lesser extent, Nokia’s Symbian (which is more widely used internationally) platforms. As Fred Wilson of Union Square Ventures alludes to, by leveraging its ability to tightly integrate its applications (Calendar, Gmail, Maps, etc.) into Android, Google can extend the operating system to provide a solution for not only consumers, but the small/medium business market as well, right out of the box. Having also signaled their intent to develop an enterprise version of Nexus One, Google will be able to challenge Research In Motion’s Blackberry platform for larger, more lucrative business clients as well this year. Combined with a strong pipeline of Android-based handsets being released by device manufacturers over the course of the year, it’s more a question of when rather than if Android will become the largest mobile operating system in terms of market share in the United States.

With such a bright outlook in mobile, why would Google be envious of Apple? Because Google wants to be more than just a search company.

Google’s mission has always been associated with organizing the world’s information and making it accessible, which enables users to more easily find content to consume. Apple, whose mission statement has evolved to include spearheading the digital media revolution, focuses on delivering this content in the form of applications, music and videos to consumers through its own devices and services. It’s this difference in how content is discovered and where it is consumed that has enabled Apple to establish a more direct relationship with both consumers and content owners than Google has achieved and, in the process, extract more economic value from both by way of hardware sales to consumers (iPhone, iPods, etc.) and distribution fees (through iTunes sales) from content owners.

Google is attempting to eliminate this relationship discrepancy primarily through acquisition. DoubleClick and, most recently, AdMob were acquired to provide Google with online and mobile display ad monetization capabilities, respectively, wherever the content is, regardless of device. In an effort to keep a larger revenue share, and further bridge the relationship gap it has with consumers who use Google to search but consume content elsewhere, Google has also entered the content business by, most notably, acquiring YouTube to help keep consumers within its network. Combined with the company’s recently failed attempt to acquire Yelp, I agree with Simon Dumenco’s assertion in his Advertising Age article that Google is attempting to become a media company in the process. Because Google’s content efforts have focused on user generated content though, the company has entered into partnerships to match Apple’s content offering- cutting deals with television networks and movie studios for premium content for YouTube, supporting an open app ecosystem on the Android platform and exploring partnership opportunities in the music space (though an acquisition of an iTunes competitor such as MOG or Spotify would make sense for Google and Android at this point).

Regardless of the number of phones that are eventually sold with the Android operating system and applications that are added to the platform, the truth is Google will never be able to replicate what Apple does, as the two organizations have completely different cultures which is evidenced in their respective approaches to mobile. Google’s left-brain, quantitative, engineering-driven approach to business isn’t organized to compete with Apple’s right-brain, qualitative, design-driven model. It’s in the design process Apple is able to foster an emotional connection between its products and consumers, something Google is unable to achieve because it provides software-based services. And because Apple design approach integrates both the hardware and software components of its devices, content providers, including Google, must work directly with Apple in order to reach these consumers. Apple’s design prowess will be on display again next week when they finally unveil the long-rumored tablet device which is expected to bring additional types of premium content from print publishers directly to consumers through these devices- adding more fire to Google’s Apple envy.

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