A recent blog note about the Google/Android business model was one of the best I have ever read on this topic (see: The Freight Train That Is Android). These ideas will have great relevance for medical and healthcare apps which currently are dominated by Apple under its mobile operating system, iOS. Below is an excerpt from the piece:
Despite all that has been written about Android, as well as its unquestionable early success, the world at large still doesn’t fully appreciate the raw power of this juggernaut....One of Warren Buffet’s most famous quotes is that “In business, I look for economic castles protected by unbreachable ‘moats’.” An “economic castle” is a great business, and the “unbreachable moat” is the strategy or market dynamic that heightens the barriers-to-entry and makes it difficult or ideally impossible to compete with, or gain access to, the economic castle....For Google, the economic castle is clearly the search business, augmented by its amazing AdWords monetization framework....AdWords is an highly respectable castle, and Google would clearly want to put a “unbreachable moat” around it....What are the potential threats to Google’s castle? Basically, any product that stands between the user and Google and has the potential to distract the choice of search destination is a threat. A great example is Firefox. Like many browsers, Firefox has a search bar built into the upper right corner. This leads to a substantial number of Google searches for which Google pays Firefox a handsome fee. From time to time, this fee must be negotiated, and as a result there are constant rumors that Firefox might chose another search engine, like Bing. Other examples include smart-phones and choices made by carriers and/or handset makers.....Android, as well as Chrome and Chrome OS for that matter, are not “products” in the classic business sense. They have no plan to become their own “economic castles.” Rather they are very expensive and very aggressive “moats,” funded by the height and magnitude of Google’s castle. Google’s aim is defensive not offensive. They are not trying to make a profit on Android or Chrome. They want to take any layer that lives between themselves and the consumer and make it free (or even less than free). Because these layers are basically software products with no variable costs, this is a very viable defensive strategy. In essence, they are not just building a moat; Google is also scorching the earth for 250 miles around the outside of the castle to ensure no one can approach it. And best I can tell, they are doing a damn good job of it.
So, to summarize, AdWords is the cash cow for Google -- in other words, the castle. The company will do whatever is possible and necessary to drive traffic to web search and therefore to its paid-for advertisements. Browsers and operating systems are the moat around this castle. It would prefer that users search using its own browser Chrome running on a smart phone or tablet powered by Android because it need to pay a fee for Firefox searches. A critical element of this business strategy is not to charge for any layer that exists between consumers and Google search.
I have written in the past that Microsoft is struggling (see: The Decline of Microsoft: The Clues Seem to Be Obvious). Although I think that part of this process is due to the company becoming too large and bureaucratic, I also think the Microsoft business model is past its "sell-by" date. The future will be largely dependent on mobile devices plus the cloud. Right now, the Google castle-and-moat business model is superior to everything else in the market with the exception of the Apple business model. However, Larry Page now seems to be meeting opposition to some of his goals and is being accused of the sin of hubris (see: A message to you, Larry). Are there other businesses with potentially superior business models lurking on the sidelines to compete with Google and Apple? You bet there are, particularly Facebook. The stakes are very high and worth a fight.
The Freight Train That Is Android
“People get ready, there’s a train a comin’”
- The Impressions
From Zacks via Yahoo: Mark Vickery, On Thursday March 24, 2011, 4:58 pm EDT “BlackBerry maker Research In Motion (NasdaqGS: RIMM – News) beat its fiscal 4Q EPS estimates by 2 cents per share, but missed slightly on quarterly revenues and offered guidance well below the current consensus. This has sent RIMM shares down nearly 10% in after-market trading…”
Yesterday, after the market closed, Research in Motion, the makers of the Blackberry device, announced that they would be lowering their current quarter earnings due to lower average sales prices. In a separate announcement, the company proffered that their new tablet will support Android apps, yet the CEO also made it clear that he believes the world is overly focused on the criticality of having a large numbers of applications on your platform. They also suggested that the guidance issue is temporary, and relates mainly to a product cycle not a systematic change in the industry.
Despite all that has been written about Android, as well as its unquestionable early success, the world at large still doesn’t fully appreciate the raw power of this juggernaut. I have written about this in the past in Android or iPhone? Wrong Question, and Google Redefines Disruption: The “Less Than Free” Business Model. But even so, the more I see, the more I wonder if I too may have underestimated the unprecedented market disruption that is Android.
One of Warren Buffet’s most famous quotes is that “In business, I look for economic castles protected by unbreachable ‘moats’.” An “economic castle” is a great business, and the “unbreachable moat” is the strategy or market dynamic that heightens the barriers-to-entry and makes it difficult or ideally impossible to compete with, or gain access to, the economic castle. Here is a great post from the 37signals blog a few years back that walks through several different examples of potential moats.
For Google, the economic castle is clearly the search business, augmented by its amazing AdWords monetization framework. Because of its clear network effect, and amazing price optimization (though the customer bidding process), this machine is a monster. Also, because of its far-reaching usage both on and off of Google,AdWords has a volume advantage as well. Perhaps the most telling map with regards to the location of the castle 
can be found in Jonathan Rosenberg’s “Meaning of Open” blog post. In this open manifesto, Jonathan opines over and over again that open systems unquestionably result in the very best solutions for end customers. That is with one exception. “In many cases, most notably our search and ads products, opening up the code would not contribute to these goals and would actually hurt users.” As Rodney Dangerfield said in Caddyshack, “It looks good on you, though.”
AdWords is an highly respectable castle, and Google would clearly want to put a “unbreachable moat” around it. Warren himself is on record suggesting that Google’s moat is pretty good already. But where could you extend the moat? What are the potential threats to Google’s castle? Basically, any product that stands between the user and Google and has the potential to distract the choice of search destination is a threat. A great example is Firefox. Like many browsers, Firefox has a search bar built into the upper right corner. This leads to a substantial number of Google searches for which Google pays 
Firefox a handsome fee. From time to time, this fee must be negotiated, and as a result there are constant rumors that Firefox might chose another search engine, like Bing. Other examples include smart-phones and choices made by carriers and/or handset makers. As an example, a few years back, Verizon set the default search box on Blackberry’s to Bing instead of Google. Despite Warren’s faith in Google’s moat, there are ways to move the needle on search share, or at least hurt the economics by demanding more profit share for distribution.
So here is the kicker. Android, as well as Chrome and Chrome OS for that matter, are not “products” in the classic business sense. They have no plan to become their own “economic castles.” Rather they are very expensive and very aggressive “moats,” funded by the height and magnitude of Google’s castle. Google’s aim is defensive not offensive. They are not trying to make a profit on Android or Chrome. They want to take any layer that lives between themselves and the consumer and make it free (or even less than free). 
Because these layers are basically software products with no variable costs, this is a very viable defensive strategy. In essence, they are not just building a moat; Google is also scorching the earth for 250 miles around the outside of the castle to ensure no one can approach it. And best I can tell, they are doing a damn good job of it.
Google has organized this defensive play with precision. Carriers and handset makers that use Android are given economics to do so. The Android version of the “AppStore” shares the majority of its economics with the carrier and handset makers. Once again, they are not building a business, they are building a moat (sorry for the repetitiveness, it’s intentional). Because they are “giving away” money to use their product, this creates a rather substantial conundrum for someone trying to extract economic rent for a competitive product in the same market.
This is the part that amazes me the most. I don’t know if a large organized industry has ever faced this fierce a form of competition – someone who is not trying to “win” in the classic sense. They want market share, but they don’t need economics. Imagine if Ford were faced with GM paying people to take Chevrolets? How many would they be able to sell? What if you received $0.10 for every free Pepsi you consumed? Would you still pay $1.50 for a Coke?
The combined market capitalizations of companies that build desktop operating systems, handset operating systems, mapping software (they give this away with Android also!), as well as internal software that helps to differentiate mobile devices is well over $100B, and may be several times that. Yet, there is no economic law that necessitates that these industries remain in their current form. When software was first imagined as a business, it seemed like a miraculous dream. Because the variable costs were zero, you would make near 100% profit on each incremental unit that you sold. Perhaps the resulting counter-force to this is that if someone can afford to build a near equivalent code base, than they can at their option price to marginal cost ($0.00), the very definition of perfect competition.
One might yearn to suggest that there is a market unjust here that should be investigated by some government entity, but let us not forget that the consumer is not harmed here – in fact far from it. The consumer is getting great software at the cheapest price possible. Free. The consumer might be harmed if this activity were prevented. And as we just suggested above, the market is finally driving towards software pricing that represents “perfect competition.”
In Silicon Valley we like to make light of industries that are facing digital disruption such as newspapers, the record industry, and the movie industry, suggesting that their executives “just don’t get it.” Perhaps now we are witnessing the disruption of not just analog businesses, but also formerly interesting digital businesses as well.
John Doerr, once said “The Internet is the greatest legal creation of wealth in history.” Android may be the opposite of that, the greatest legal destruction of wealth in history.
Google has attracted countless new clients and users to their internet search engine by taking over the Android os phone market. Although Android os is an free os, many of the Android os phones bear Google's brand.
Posted by: Timothy Nixon | March 08, 2013 at 03:55 AM
Great article about their business model, I really learned a lot. Thanks.
Posted by: call recording | December 12, 2011 at 11:37 PM
One of the problems with Google's approach is that the value proposition of its advertising model fails to add authentic value for users of its devices. Apple is able to offer value to users in a number of different ways because, as you mention, Apple controls the seamless integration of hardware and software - that is the fundamental element of its value proposition and it does so better than any other hardware or software company.
Posted by: Android Spy | June 28, 2011 at 06:22 AM