Google and Moto: Strategic Intent and Consequences

Capital, whether it is tangible or intangible—such as IPR, is the residue of past labor. For technology companies with a great past but not such a great future (e.g. Nortel, Motorola, Kodak) their current market value of debt and equity appears to fall short of the current value of their patent portfolios alone. This divide is a significant opportunity for shareholders and for patent-hungry companies hunting for an acquisition of an IPR portfolio. The announcement on August 15, 2011, of Google’s agreement to acquire patent-rich Motorola Mobility for $12.5 billion is an industry shakeup likely to create big ripples.

Vertical transactions such as this show that the industry is rounding the corner. After years of horizontal industry unbundling (described in an earlier post), the handset industry in the smartphone era is moving away from PC-like commoditization. The industry is moving back towards the integrated industry that handsets were until the end of the 1990s, as The Economist wrote this week (Economist 2011).

What is Google’s strategic intent of this vertical transaction, and what are the consequences? Google wins in four ways. The first three of these are defensive:

  • On the short term, Google obtains patent currency to strengthen its position in the ongoing IPR wars. Android players are under attack from rival ecosystems (Apple and Microsoft). Including a license to the Motorola patent portfolio in the Android license could be Google’s umbrella for these Android players. This will contribute to protecting Android’s market share. In this case, the patent wars between rival ecosystems fuels vertical integration. In the long term, patent wars—like price wars—destroy industry value. They are counterproductive and will eventually stop.
  • Google can maintain or increase Android’s market share, so that Google retains control and doesn’t become hostage to Apple, Microsoft/Nokia, or Android OEMs (HTC, LG, Samsung etc) for traffic hence ad revenue.
  • Google can offer its own handsets at a low price subsidized by future ad or content revenue. This allows Google to become less dependent on mobile operators’ handset subdisidies. Competition will increase: data plans from operators will become less expensive, and probably also less sophisticated (more unlimited plans, less tiered pricing). Where applicable, operators might have to offer the open device if it is sufficiently compelling. Switching barriers for consumers will be significantly lowered. Churn will increase. Customers who bought a phone subsidized by Google will find it easy to switch between networks to get the best deal. Lower connectivity costs and larger data buckets will lead to more traffic hence more ad revenue.
    Mobile advertising is still small—compared to a total online advertising market of some $80 billion according to eMarketer (Oser 2011), the mobile advertising market is sized at $4.3 billion globally this year with a 52% share for Google (ABI 2011). Assuming Android retains its strong position as the leading software platform on smartphones, Google is well positioned to retain that mobile advertising market share as the market hits an estimated $24 billion by 2016 (ABI 2011).
  • The same applies to the wireline internet. Motorola Mobility is the world’s leading maker of TV set-top boxes, another CPE which is heavily subsidized by the operator. Google’s ad revenue generating software on this hardware gives it the ability to subsidize the set-top box and drive operator pricing power downwards. Connectivity prices will decrease, churn increase. Motorola’s home automation, set-top box and residential broadband equipment businesses now gives Google a platform from which to jump into the home.

The downsides to Google are the following:

  • Handset OEMs using Android will realize how dependent they are on Google and how quickly Google’s change of course can change their businesses. Some may defect to rival OSs. Android held a 43.4% share of the smartphone market at the end of the second quarter, ahead of Nokia’s 22% and Apple’s 18%, according to data from research firm Gartner (Pettey & Goasduff 2011).
    Microsoft, an alternative horizontal software platform, could potentially benefit. This is the flipside of the second bullet above. The Motorola deal disrupts to some extent the mutual dependency between Google and the handset OEMs.
  • Google diversifies into a lower-margin, highly competitive industry where it has little experience. Mobility makes no money on its handsets right now. Apple’s operating margins are akin to those of Google, at around 32%. But they are an anomaly in a cut-throat industry where Apple’s superior product and brand enable it to charge premium prices even as it builds market share. It is doubtful Google can replicate that.

Will Google continue to make hardware long term? Some observers believe it won’t. If Google wants to maintain a robust growth rate, not dilute its margins and its advertising-focused strategy, it should dispose of the hardware business in the long term. Yet the arguments provided above show that, in the long term, there is strategic rationale for Google owning the hardware. Google has the potential to disrupt telecoms and consumer electronics in strategically the same way it has disrupted the software industry. In this case however, the challenge is in the execution of a vertical integration considering Google’s lack of experience in the hardware industry.

Google may not take that route. Conflicts of interest may force it to choose between vertical integration and selling off device production at Motorola Mobility.

The market doesn’t provide a strong consensus view on the way in which this trade-off will work out. First of all, there are doubts whether Google will boost Motorola’s free cash flow. Shares in Motorola’s Asian suppliers jumped, but excitement quickly ebbed. Three days after the news, Foxconn International Holdings Ltd, the world’s top cellphone ODM which counts Motorola as a client, had increased 3.5% on prospects of more business, compared to a 2% increase in the Hang Seng (HSI) index. Shares of Compal Communications Inc and Arima Communications were among a slew of Motorola suppliers that hit the 7% daily limits in Taiwan during several days, to gain 14.4% and 7.8% respectively three days after the news (Taiwan’s TSEC index lost 0.3% in the same period). Those gains have been lost since, as the following figure shows.

Share prices of selected Motorola Mobility suppliers (left) and Android handset OEMs (right) since the announcement of the acquisition on August 15, 2011

Handset OEMs that use Android fared less well. Despite initial excitement about the increased patent protection the deal brought, shares in Samsung Electronics Co Ltd. (a diversified firm which has businesses from chipsets to TVs to energy to phones) ended 0.3% higher three days after the news broke, in a Korean market (KOSPI) which edged up 3.8%. HTC, first to roll out an Android-backed smartphone and the main Android-based OEM, is most exposed to any shift in the industry landscape. HTC lost 3.4% in a Taiwan market down 0.3%, followed by further losses in recent days.

ABI (2011). Mobile Advertising. ABI Research. June 2011.

Economist (2011). Patently Different: Google’s Takeover of Motorola Mobility. The Economist. August 20, 2011.

Oser K. (2011). Worldwide Ad Spending: Online Drives Growth. eMarketer. August 2011.

Pettey C., Goasduff L. (2011). Gartner Says Sales of Mobile Devices in Second Quarter of 2011 Grew 16.5 Percent Year-on-Year; Smartphone Sales Grew 74 Percent. Gartner. August 11, 2011.

Tags: , , , ,

Comments are closed.