The Internet seems to be full of stories and analysis every day about who is winning and who is losing the smartphone wars. However, I think that Google (NASDAQ:GOOG) has been a clear winner in the smartphone wars till now. The company has managed to install its OS (and ecosystem) on a majority of smartphones and tablets without spending too many resources. It has used Microsoft's (NASDAQ:MSFT) tried and tested strategy of beating the competition by giving a product away for free. Google's Android OS has been a masterstroke which has converted more than one billion first time mobile device users into Google customers. While Google is not making too much money from the Android OS, it is making its competitors such as Apple (NASDAQ:AAPL) and Microsoft lose a large amount of money. While Android may not be the best mobile OS, it has a great value proposition given its zero cost to customers. Now Google is preparing to further hurt its competitors by selling cutting edge smartphones at a very low price.
Motorola has been a failure (until now)
Google bought Motorola for $12.5 billion to defend itself from the patent attacks by strong established technology companies like Nokia (NYSE:NOK), Apple and Microsoft . While the technology old guard was not directly attacking Google, they were suing major Android users like HTC and Samsung (OTC:SSNLF) in courts around the world. Even now, Nokia and Apple have not let up on their attacks against major Android companies. Microsoft is rumored to be earning ~$1 from every Android shipment while Ericsson (NASDAQ:ERIC) has also joined the patent feasting party by targeting Android players (even small fish such as Micromax). Motorola has not been able to reverse its operating system losses as it continues to lose smartphone market share. The company is undergoing a painful restructuring as Google has fired thousands of Motorola employees and sold off non-core assets. The Motorola segment has been a pain point for Google even as its other segments continue to show strong growth.
Can Motorola come up with the goods?
Google recently announced that it would start manufacturing the first smartphone in USA and is hiring thousands of workers for a new factory in Texas. The new smartphones that will be made by Google's manufacturing unit are supposed to be game changers, that will remove the most common problems associated with smartphones today. They will be water-proof, have unbreakable screens and will automatically adapt to user needs. Samsung brought in a new feature whereby the smartphone scrolls depending on the eye movement of the user. The new "Moto X" phones will take this feature much further and will automatically go into different modes. "Google Glass" has the potential to disrupt the entire technology industry by being the first mass produced commercial "wearable computing device". The new smartphones announced by Google has the potential to disrupt the current $350 billion mobile devices industry as well.
How Google can destroy Apple and Samsung margins
Google's new hardware products are not meant to create large profit making segments for the company like Apple's iPhone and iPad products. They are meant to tighten Google's hold on the world's information flows. Google is currently selling its Nexus 4 smartphones at cost. This LG manufactured device has terrific specifications and is easily the best Android smartphone at the current price. Even the Nexus 7 manufactured by Taiwanese electronics company Asustek is a terrific device. The advent of Nexus 7 at just $199 changed the entire tablet market. The Nexus 7 has become the benchmark device for the 7 inch tablet space, which is the fastest growing segment in the tablet industry. Google is trying to lower the margins of its competitors, by pricing great hardware at cutthroat prices. However, Google has not come out with anything that beats the competition in features. The new smartphones that Google has announced would bring new innovative features that no current phone has. If Google prices it below the competition, then other companies will be forced to drastically cut the prices of their flagship products. Google wants to cut down the 50% gross margins being made by Apple on their smartphones. Samsung too is prone to a huge hit in its profits, if Google comes with cutting edge Android smartphones.
Google has disrupted existing industries and can do so again
Google's core business of Internet search is a monopoly which rivals have failed to break. Facebook (NASDAQ:FB) has come out pitiable copies of Google's search engine while Microsoft has also failed in search, despite spending billions of dollars in marketing and developing its Bing search engine. Yahoo (NASDAQ:YHOO) has more or less given up competing with Google head on, as it relies on MSFT technology to power its own search engine. With its core business safe, Google has the luxury to spend billions of dollars on new technologies and products. Some of them like Youtube and Android have been spectacularly successful. There is no reason to believe that new smartphones made by Google cannot be equally successful. Google has disrupted the entire media industry with its Ad sense advertisement exchange and "Google News". The company has forced major media companies on the back foot.
Google has made enemies of almost all big technology players such as MSFT, YHOO, FB, Apple etc. These companies are spending resources to counter Google's attack on their fiefdoms. Some of them are collaborating with each other to stop the Google juggernaut. Microsoft, Nokia and others have filed a complaint with the EU, against Android while an Apple led consortium bought Nortel's patents outbidding Google. These enemies have formidable technological strengths and cannot be underestimated in their potential to disrupt Google's current winning streak
Google has not mass produced any commercial hardware product to date. It still gets the lion's share of its revenues and profits from its search engine. The jury is still out in deciding whether Google can manage the complex supply chain in producing a smartphone today. The supply chain and marketing expertise has not been proven in Google's case. The company also risks antagonizing its Android partners if it starts selling too many of its own smartphones. There are already alternatives like Windows 8 OS as well as the new Firefox OS. The best product and service does not necessarily win in the marketplace.
Google's Stock Price and Valuation
Google's stock price has outperformed its peers as it continues to show great results almost every quarter. The company has shown tremendous innovation despite its huge size by constantly bringing out new products and services. Despite huge competition, the company has managed to retain its growth and margins. The company's stock is expensive when compared with the low double digit P/E of its competitors like Microsoft and Apple. However, the company's forward P/E at 17x remains roughly on par with that of the general market. The stock price has been making new all time highs and remains 5% shy of its all time high price of $920.
Apple revolutionized the smartphone market with the introduction of its iconic iPhone rapidly becoming the No.1 player converting leaders like BlackBerry (NASDAQ:BBRY) and Nokia into fringe players. Google also has the potential to do the same with Apple and Samsung, though the company still needs to execute on its vision. The new smartphones are a great idea but bringing it to fruition will require tremendous efforts from Google's top management. The company is essentially a software player and has little experience in electronics hardware. There are very few companies which have managed to make decent profits in hardware for a sustainable time period. MSFT lost a lot of money in Xbox One before it could make profits. Even stalwarts like Sony (NYSE:SNE) have found it very hard to sustain a decent operating margin in electronics. It will not be easy for Google to displace the mobile leaders from their pedestal. However, this scenario needs to be watched carefully as it can create lucrative short opportunities.