Peaking Companies: Apple Has Ripened

Disclosure: I am an Apple user; I have a MacBook Pro, iPad2 and iPhone 4S.  I am quite happy with these products, but I am not a raving fan. Why? There are lots of little disappointments and annoying features that seem easy to fix. Now my attitude is positive/neutral, but I would consider other brands when I purchase my next new device.  

Disclaimer: This should not be considered advice for buying or selling any equities. Personally, my stock picking record is not good, so I have given it up and do not hold any individual equities in any companies about which I write. 

We have seen it before: big corporations get so big and consequently, they have difficulty with technology inflections, the need to increase their addressable markets, and adding more markets to continue their glory and meet the expectations of Wall Street.

Historically, I have observed that companies are slow to admit there is a problem and turnaround/comeback plans are audacious and high risk and usually unsuccessful. IBM peaked back in the 1970s before minicomputers ate their lunch. DEC rode the minicomputer wave, peaked in 1987 and was a shell of its former self in just five years. Dell and HP have similar stories. We have too many examples of companies soaring and becoming high fliers and then dropping and in some cases crashing rapidly. History is repeating itself; Apple is now in this category.

Apple has had an amazing run of growth, great products and huge profits. It seemed it could do no wrong, but that was then.  Now, it seems the company can do little right. iPad mini was not very impressive; AppleMaps was a disaster; the iPhone 5 was somewhat disappointing. Not only did the iPhone 5 force everyone to a different charger, but it also broke Bluetooth connections with many devices. The result is that are doing major damage to the brand, resulting in a reduction in demand for iOS devices.

Many Apple fans are abandoning their apple product and are considering other brands — unconceivable just a few years ago. This is natural as the essence of brand is human reaction/feelings, and our emotions are influenced by little things. If enough little things accumulate it triggers a cognitive switch, and we generalize those little negative feelings toward everything about that brand. (Banks, cable and telephone companies have this problem.)

Apple has reached its long-term peak (two to five-year frame), and it will not regain its glory. Since the company no longer has a one-of-a-kind product visionary, Apple needs to either replace the visionary or transition to a different business model. Because it was able to produce great new products or create all new categories every four to eight years, it could beat competitors to market, command higher prices and higher margins. In an incremental product enhancement model, profits are challenged with lower margins, and competitors Samsung and Google are formidable if you do not keep changing the rules of the game or the categories.

IMO, Apple’s major problem is that it lacks a product visionary. Steve Jobs was a genius, and it is hard to replace that. There are other models to foster insanely great innovations absent a superstar, but I do not see this yet in Apple. Tim Cook appears to be a reasonably good manager, and Jonathan Ives is a great designer, but neither are product visionaries. It is not easy, and maybe they need to change the culture, policies and attitudes towards innovation. They have already started to follow Google’s lead with the Blue Sky initiative (employees are allowed time to pursue projects); however, it won’t work without real buy-in and respect from top management. Until we see that, do not expect Apple to return to its former self any time soon. 

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David Dines
ddines@acgresearch.net
www.acgresearch.net

Google-Motorola: Can This Marriage Be Saved?

Stock plunge, premature earnings release, Motorola's losses, what more could go wrong for Google?

To say that yesterday was not a good day for Google would be a gross understatement. RR Donnelly, its financial printer, released Google’s Q3 results in the middle of the day (East Standard Time), rather than after the markets closed. In addition to the embarrassing snafu, Google’s profits were well below expectations. Since Wall St. hates surprises, the double whammy caused the company’s stock price to decline 8% on 6 times the normal volume. 

Much of the media attention is focused on the weakness in advertising revenue. Total activity is up, but the cost per click is declining, in part driven by the move to mobile, which commands a lower price and potential competition from Facebook. Only a few analysts and reporters focused on the more than half a billion dollar GAAP loss from Motorola this quarter. 

I have been consistently (since its announcement) saying that the Google-Motorola wedding was not a match made in heaven (read the original blog here). My analysis focused on how Google’s poor track record with hardware, its potential conflict with its customers and how the cultures did not fit. (Yes, I may be wrong in the long term if Google can successfully expand its Kansas City gigabit fiber experiment nationwide and have a captive market for its CPE, but that is a big if). 

The company’s results to date have been validating my position. The Home segment was down over 3% Y-Y, which will likely reinforce its market share losses. Interestingly, my comments about the Home segment were more pronounced for the mobile segment, which was down 27% Y-Y this quarter. Since I do not focus on mobile handsets directly, I did not write much about the mobile segment. In hindsight, this is not a surprising outcome given how competitive the handset space is and how aggressive Samsung has been in its battle with Apple. 

Year-to-Year Change	3Q11	4Q11	1Q12	2Q12	3Q12
Home	-9.5%	-10.3%	-2.2%	-8.4%	-3.4%
Mobile	19.7%	4.7%	3.1%	-24.7%	-27.0%

Google is facing serious issues in its main business and the distractions of a half a billion loss from Motorola, weakness in the handset business, and the slow decline in the home segment are not helping it financially or strategically. Maybe it is time for a divorce? 

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David Dines
ddines@acgresearch.net
www.acgresearch.net

Google Acquiring Motorola: Mash-up or Crash-up?

(Note: This post was originally posted in August 2011.) The big news rocking the wireless, handset, tablet market is Google’s bold bid for Motorola Mobility Inc. This is excellent news for Motorola Mobility’s (MMI) investors and MMI’s shareholders who were faced with the prospects of a long slog of an unprofitable business in an unrelenting competitive environment. However, the long-term prospects for Motorola as a Google company look pretty dim.

It’s about patents

The primary driver of this acquisition is the patent portfolio. It seems that much of the fight over mobile is going to be over patents, and Google needs to shore up this weakness. Google is moving to a vertically integrated business model, which would enable it to increase margins and revenues in the mobile business. Google can now make money on the hardware, the Android ecosystem. Additionally, in-house hardware expertise should result in faster development and more robust software. If it succeeds in taking Apple’s basic business and adding a degree of openness, Google could become the master of the mobile universe, which would enable it to charge premium pricing.

The acquisition will succeed in giving Google a solid patent portfolio for waging both offensive and defensive IP legal battles. However, given the amount of money paid, Google needs to get more than just a patent portfolio. Google also acquired a mobile device manufacturer and a cable TV equipment company (the Home division sells set-top boxes, cable modems, CMTS, optics, QAM and other network gear).

Clipping Android’s wings

As a mobility play, this acquisition makes as much sense as Microsoft buying Dell. There is a very high risk of alienating the other vendors, because the temptation to play favorites will be too great. Even if there is no actual favoritism, the appearance of preferential treatment will be enough to create issues. Google just gave all the Android ecosystem partners a compelling reason to execute plan B and start evaluating overtures from Microsoft. Do not expect to see any company shift strategies in the short term, but the long-term growth trajectory of Android just got clipped.

The mobile handset market is a low-margin business with tremendous risk, especially if a product does not sell as expected and heavy discounting is required to move inventory. MMI’s gross margin in Q2 was less than 26 percent and that includes the approximately one-third of its business from the Home division, which has much higher margin products and for which they pay nothing for Android licensing.

Google also has not been very successful in consumer hardware: the Google Nexus One failed, the Nexus S seems to be lost in a crowded field and Google TV is on the ropes (currently returns are exceeding sales of the Logitech Revue, see WSJ article). With this track record, it will be interesting to see how well Google competes in this market.

Clash, bottlenecks, delays

From a culture and operations perspective we would expect major assimilation issues and major delays in key decision-making. Cultures and bureaucracies will certainly clash, which will contribute to bottlenecks and delays in product development and delivery. It will be interesting to see new hardware designs from the combined companies, as designers try to please two masters.

This acquisition puts more pressure on MMI’s Home division; it is a great opportunity for competitors to take more business from Moto and accelerate its share decline. The Home business seems to get less attention from Moto management than its sexier sibling, and the uncertainty and distraction from the acquisition will exacerbate this situation. The Google name may be great with consumers, but not with service providers. Service providers already distrust Google because of its stance on net neutrality and its 1G FttH project. Furthermore, Google is trying to muscle in on their main source of revenue with OTT (and have a direct relationship with the customer, excluding the SP). If Google can get over these hurdles, it has to sell its vision and fight the perception of putting out half-baked software and putting little effort into customer support.

Regarding business models, there are dangers in trying to chase Apple at a game that it has spent decades perfecting. While imitation is a sincere form of flattery, it is a bad business strategy for most companies. Bottom line, other than getting a decent patent portfolio, this deal is not going to be worthwhile for Google.

David Dines
ddines@acgresearch.net
www.acgresearch.net

Are You Ready for the Cloud?

A recent study of providers across the globe concluded that traditional carrier and Telco providers are not ready or not able to offer cloud alternatives. Even those providers that have acquired cloud companies still are challenged to find the right sales force to migrate enterprise subsystems to the cloud.

Approximately 70 percent of 600 CIOs surveyed indicated that they spend 13 percent of their budgets on service provider public cloud as an infrastructure in a managed offer, and they estimate their demand will grow to more than 40 percent in three years. This development is forcing enterprises to evaluate their business processes across all departments and identify how cloud can support them.

The decisions are not clear cut. For example, a company may need higher security on premise managed by local or onsite resources owned by the company, but for communication and collaboration the company needs public cloud offers. For back-up and recovery a relationship with a provider or MSP may provide a solution that makes the cloud attractive for reducing resources and access to data. Before selecting which cloud solution is right, each process should have identified requirements and risk rate, and the solution should meet those demands by process or client.

Providers, therefore, must address the obstacles they face when dealing with enterprise customers. Cloud offers from such companies as Amazon, Microsoft and Google can almost fully support the small-medium business self-service customers, but their models are completely inadequate for enterprises, which have often relied on traditional providers for SLAs for connectivity. It is not certain that these providers can manage the cloud SLAs. To effectively meet enterprises’ requirements, providers will have to initiate major restructuring of their go-to–market, sales and delivery systems.

Some providers have already filled their gaps in cloud offers: OpSource, Terramark and Savvis and other providers have purchased other companies to acquire cloud offers. But it still remains to be seen if they can they sell their cloud offers. Only NTT, which purchased Dimension Data and OpSource, has the system integration skills to sell the offer in a consultative fashion. Even if each of these companies have cloud offers, getting the offer to market and selling it will still take several years. To fill their cloud gaps, Telcos must acquire, partner or build to meet the demand.

‪Which companies will be the winners in off-premise cloud? How will the market evolve between SPs (Verizon), asset-heavy system integrators (SI) (CSC), over the top players (Amazon, Google), cloud pure plays (Rackspace)?‬ It is unlikely that Rackspace’s, Amazon’s or Google’s offers would be considered an enterprise infrastructure offer as they have limited ability to address the SLAs of enterprises. Service providers address SLAs for connectivity; however, they will need to develop the consulting skills to enable migration of subsystems to public or private cloud.

Obstacles preventing companies from delivering vary. Verizon has more than 300 SIs or professional service staff that must be trained, and the company must deal with changes in leadership, alignment with Terramark, and lack of processes. Savvis/Centurylink has the same challenges. NTT is quickly retooling DiData to sell cloud offers. This company is the only one with the SI, cloud and connectivity of SLAs for enterprises. Some outsourcers such as CSC have good white label vBlock (VCE) stacks that will be a standard offer in the cloud. Just as Ericsson, IBM and HP do with different infrastructure technologies, some just as these Sis do will also manage infrastructure as an outsourcer.

‪As it currently stands, partner-to-partner partnering with vendors is the primary strategy that would really change the cloud market, because it is the quickest way for providers to move from connectivity providers to full offers of cloud enablement. Vendors have deep relationships with system integrators and have created loyalty and preference with top-level integrators, for example, Accenture, IBM and HP. Service providers, Tier 2 and cable operators that create partnerships with low-end vendors, which have SI Lite VAR partners, will be able to target the mid- to low-end market with loyalty, incentives, training and partnering offers. Partnering for risk-adverse Telcos enables them to change, invest and move to new technologies. Partnering 1) allows for white labels for cloud offers and the acquisition of go-to-market sales skills; 2) reduces investment up front for cloud-based offers (if white label is leveraged); 3) reduces sales staff training; and 4) derisks the cloud for the provider’s sales team, which is generally focused on connectivity.

‪Providers need to refine the lifecycle of their offers to increase their chances of offering targeted cloud services. They need to really understand their subscribers, for example, are they wireless or wire line (they know which but not what the business is)? Service providers must identify connectivity requirements, for example, size, and most importantly, understand their customers’ business IT processes, needs and systems. Once these factors are fully understood, providers can develop consulting and migration strategies and successfully deliver cloud to enterprises.

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Lauren Robinette
lrobinette@acgresearch.net
www.acgresearch.net