Google at Risk

Google continues to dominate the search market. It commands about two-thirds of all the searches done on the internet. Its next closest rival is Microsoft’s Bing which, at 28% market share, includes its integration with Yahoo’s site. (See “Audio Tip #9: Introduction to Step 3 of the Basic Strategy Guide” on StrategyStreet.com.) Google’s dominance in this market has brought with it a disproportionate share of the spending on paid advertising. Google may be putting that premium position at risk.

Google has been investing heavily in developing its local search capability. It hopes to gain even more advertising dollars by making this investment. Now the problem. Some companies, who also specialize in local marketing have begun complaining that Google discriminates against their sites in favor of Google’s own local search results. This is a very dangerous development for Google. It risks its Reliability reputation.

Google’s competitors have had a difficult time gaining market share against Google. As competitors develop new Functions, Google simply copies them. Internet searchers have had little reason to shift from Google to other competitors, including Bing. In our terms, Google’s competitors are not able to take market share away from Google by “winning.” (See “Audio Tip #32: Introduction to Step 7 of the Basic Strategy Guide”) They have not been able to do anything unique that causes a substantial portion of customers to shift their searches to Google. Rather, most of the market share that shifts in this market today comes as the result of a “failure.” Google must fail to meet its searcher’s expectations in order for Bing and the other competitors to have a significant opportunity to gain market share.

Google may be creating this opportunity by risking a failure in Reliability. A searcher has to know that Google will provide the most relevant results. If Google offers up its own less relevant results ahead of other web sites’ more relevant results, Google will lose market share. (See “Audio Tip #72: Reliability Failures Among Outstanding Companies” on StrategyStreet.com.) Google’s actions in promoting its own results over more relevant results are equivalent to a retailer offering a customer a lower quality product over a higher quality product simply because the retailer makes more money with the lower quality product. After a while, customers catch on and defect to other retailers. A failure in Reliability is particularly troublesome because trust is so hard to rebuild.

Microsoft Phone 7 - A Long Row to Hoe

Recently, Microsoft introduced Windows Phone 7 Mobile software. This is all new software that Microsoft hopes will stop its slide in market share. It is going to have tough sledding.

Until this introduction, Microsoft’s market share in the mobile software business was dropping off a cliff. The company was one of the early entrants into the market. In 2004, it owned 22% of the market. By 2009, its share was down to 9%. Today it is about 5%. Microsoft was quickly fading away. But maybe the new software can help.

For a bit of perspective, we have to explain that there are five separate players involved in this marketplace: the operating system developers, the phone manufacturers, the wireless carriers, the software application developers and the ultimate users. Each of these entities are in separate businesses and represent separate competition. Microsoft plays in the market exclusively as an operating system developer. That’s what Windows Phone 7 is. The Google Android system is another stand-alone mobile operating software platform. So has been Hewlett Packard’s Palm mobile operating software. Three other competitors offer their operating software only in combination with their handset hardware. These include Nokia, with the Symbian operating system, Research In Motion’s Blackberry products and Apple’s iPhones.

The market share ranking today among those competitors in total operating software starts with Nokia’s Symbian, followed by Android, then Blackberry and Apple. Each of these has a market share that are multiples of Microsoft’s current share. Microsoft is fifth, followed by Palm and others.

The new Windows Phone 7 software is a wholly new product. It is completely different than the previous Microsoft mobile software. So different, in fact, that none of the thousands of applications written for the previous Microsoft software will work with Windows Phone 7. The company must start from scratch with applications.

Consumers love applications and make many of their buying decisions on the basis of these applications. (See the Perspective, “When to Compete on Features” on StrategyStreet.com.) Today, Apple has about 250,000 applications, followed by Android with about 70,000. The differences between the two are probably much less than these numbers would indicate because most of the popular applications are available on both platforms. You can see this in the marginal purchases. Android garners more of the current new purchases than does Apple. So, for all practical purposes, Apple no longer owns a significant application lead on Android.

Windows Phone 7 faces a real hurdle with applications. In some ways, it offers a few benefits over the Android and Apple operating systems. For example, it works off of “tiles” that enable a user to get information somewhat faster than in the Android and Apple software. It works easily with Microsoft Office software and it enables gamers to connect to online games easily. These are modest innovations at best, and likely to be followed by others quickly. For example, Motorola already produces software for its phones that pretty much duplicates Microsoft’s “tiles.” Apps are the big problem.

If you are an applications developer, Microsoft would likely be far down your list of the companies for whom you would write new application software for a smart phone. Android and Apple would lead the pack. Nokia, Research In Motion and others offer more current customers than Microsoft but pose difficulties for developers. Microsoft would fall below all these firms. Microsoft has to solve this problem quickly.

Application developers are also likely to be leery of Microsoft and its continued presence in the market. Not only has the company lost share, but it introduced a software platform called Kin in the spring of 2010 aimed at young people, between 12 and 20. This product did not stay in the market even two months. So developers are likely to hold fire on their application development for the Windows Phone 7 platform until they are relatively sure that the product will succeed.

Microsoft is backing its Windows Phone 7 introduction with a $100 million advertising program emphasizing the ease with which a user can get to the information most important to the customer. This seems to me to miss the mark. This advertising investment is a Convenience innovation that advises the customer why the Microsoft system is faster and, therefore, better. (See “Video 15: Definition of Convenience” on StrategyStreet.com.) But it seems that most of the smart phone purchases today are the result of other current users’ recommendations and demonstrations. This is a Reliability innovation. These current users are apt to emphasize the Function benefits of their phones rather than the speed of access to information.

Microsoft might have spent this money differently. It is already paying some developers to create applications for its platform. My guess is that their $100 million might have been much better spent paying for applications, where Microsoft is likely to fail on the basis of lack of Functions rather than paying for the Convenience innovation of advertising.

Market Share Volatility in a Fast Growing Market

The smart phone market continues to grow quickly. The market for the operating systems on smart phones illustrates one of the patterns you will see in a fast growing market.

In order to see these patterns, we will use the Customer Buying Hierarchy. We will evaluate the reasons for market share volatility using the Customer Buying Hierarchy. Market share volatility is market share that moves from one supplier to another. (See “Audio Tip #26: Introduction to Step 6 of the Basic Strategy Guide” on StrategyStreet.com.) This market share movement may happen because new customers enter the market, where all competitors may compete for the customer, or because customers simply change their suppliers. The Customer Buying Hierarchy (CBH) holds that customers buy: Function, Reliability, Convenience and Price, in that order. (See “Audio Tip #95: The Customer Buying Hierarchy” on StrategyStreet.com.) New Functions or lower Prices dominate the causes of market share volatility in fast growing markets.

The emergence of the Apple iPhone, with the Apple operating system, illustrates the impact of new Functions. The Apple operating system virtually exploded on the market and probably created the consumer interest in smart phones. Apple was able to gain a quarter of the smart phone market very quickly on the basis of its many unique Functions, the result of the thousands of apps written for the operating system.

More recently, the growth of the Android operating system illustrates the second major driver of market share volatility in high growth markets, low Prices. The Android operating system is growing very quickly now, taking share from the Research in Motion, Apple and Microsoft operating systems. What is its advantage? It’s free. The handset manufacturers and the cell phone service providers like an inexpensive operating system. So, it turns out, do many customers. The Android operating system is now grabbing market share by the handfuls. There is no let-up in sight.

Apple's Future in Smart Phones - Part II

Apple is the clear leader in today’s consumer smart phone market. Research in Motion leads the commercial market. I am going to make the case that a few years from now, they will have a single digit market share. They will turn into a Performance Leader, a small high-priced competitor in the market. (See “Video #24: Price Point Specialists in Hostility” on StrategyStreet.com.) This position will be similar to the one Apple holds today in the personal computer market. In Part I of this blog, we described the evolution of Apple in the personal computer market. Apple today produces a marvelous personal computer. It appears that Apple is following the same map in the smart phone market as it followed in personal computers.

Apple owns both the hardware and the software in its smart phones. And it keeps both exclusive to Apple. It had early mover advantage so it garnered virtually all of the apps that people cared to develop for its smart phone platform. But a new competitor has emerged in the Android operating system. Android fills the same role as Microsoft did in the personal computer industry. Microsoft was cheap and available for many hardware platforms. The PC attracted the most app developers. Android is cheap and attractive to app developers. On the other hand, Apple has made life difficult for app developers by forcing them to jump through hoops in order to gain approval to offer apps on the Apple iPhone platform. Today, Apple has something north of 200,000 apps. Android has 70,000 apps. But, as one analyst noted, every app that a number of people are likely to want to use today is already available for both the Android and the iTouch. Apple may have more apps, but most of the apps exclusive to Apple appeal to narrow niches.

Now let’s play forward the next few years. (See “Audio Tip #32: Introduction to Step 7 of the Basic Strategy Guide” on StrategyStreet.com.) Motorola, HTC, LG and Samsung are among the many companies producing Android-based phones. The Android market is growing quickly. It will grow even more quickly as the prices of the Android handsets fall under the pressure of competition in the smart phone hardware market among some big, capable companies. Within a year, the app developers will write new apps, first for the Android platform and second for the Apple iPhone or other smart phone platform. Several years from now, the intense competition in the hardware market will reduce the cost of an Android smart phone low enough to remove a good deal of the profit that Apple now enjoys with the iPhone. (See “Audio Tip #102: When is Price Likely to Go Down?” on StrategyStreet.com.) As the Android smart phone producers continually add the features and capability to make their phones unique for consumers, the Android phones will be nearly as capable as, if not the equal of, the Apple iPhone. And, the Android phones will be much cheaper. Apple will be pushed into a Performance Leader position, where it offers high-priced feature-rich phones and garners a share of the market likely to be in single digits. This will not happen overnight. The smart phone market is still in its infancy. But check back in three to four years.

It will be interesting to see whether this competitive pattern holds in the tablet computer market as well.

Apple's Future in Smart Phones - Part I

Apple is the clear leader in today’s consumer smart phone market. Research in Motion leads the commercial market. I am going to make the case that a few years from now, they will have a single digit market share. They will turn into a Performance Leader, a small high-priced competitor in the market. This position will be similar to the one Apple holds today in the personal computer market. It appears that Apple is following the same pathway it followed in the personal computer market. Perhaps a bit of history is helpful here.

The business model of Apple differed from that of the PC. Apple was not the first personal computer, but it was, by far, the best. And, it got paid for being the best. Apple really created the mass market for personal computers. It had a huge percentage of the marketplace by the time 1981 rolled around and IBM introduced the PC. Apple controlled both the hardware and the software for its personal computer products. On the PC side, Microsoft’s Windows controlled the software, while a large number of companies became hardware producers for the Windows operating system. In the early years of the personal computer, the hardware was far more expensive than the software.

The PC market had a great deal more competition…and cost/price reductions. Apple prevented any other hardware producer from copying its products. There was at least one company who tried, Franklin Computer. But Apple killed them off in the mid-1980s. From that point on, there were no clone producers of Apple machines. The picture was very different on the IBM/Microsoft side. IBM found itself facing many competitors. Most of those competitors we called “clones.” Dell was one of those clones. This large number of hardware competitors reduced the cost of hardware drastically during the late 80s and through the 90s. (See “Audio Tip #196: Why Economies of Scales Exist” on StrategyStreet.com.) The source of much of the cost of the hardware for a personal computer shifted to the Intel or AMD chips embedded in the hardware. Still, AMD constantly challenged Intel, so Intel had to reduce its prices in order to maintain its very high market shares in chips. All of this intense competition reduced the cost of hardware until today the software costs as much as the hardware. Competition forced hardware components and prices down to such an extent that the PC platform had significant price advantages over the Macintosh/Apple platform. Apple was pushed into a high-cost/high-priced hardware position.

The competition in software was much less pronounced. It has only been in the last few years that Microsoft has had to respond to lower cost competition from Linux and Google. These lower cost competitors have had an impact on Microsoft’s prices, but nothing like the impact that the hardware competition had in reducing the price of hardware. The mass market followed the lower priced PC market. Apple today produces a marvelous machine. It has rabid and loyal fans. It also has high prices and a single digit share of the personal computer market. Were it not for the genius of Steve Jobs and his cohorts at Apple inventing new products with higher margins, Apple would be struggling today, much as it was before Steve Jobs returned to the company. It wouldn’t make a lot of money in the personal computer industry because the industry Standard Leaders, the PC producers, are so cost effective, and so much lower in price, than is Apple.

In Part II, we will see how this same pattern is playing out in the smart phone market.

Who Are Those Guys?

Whenever an industry finds itself in the enviable position of having freedom in pricing, it usually finds that competition emerges out of the woodwork, from the least expected places. In many cases, the companies in these industries don’t conceive of new competition really having much of a chance to emerge. If they do see competition, they usually dismiss that competition as incapable of offering real competition.

Microsoft dominates the PC software market. It is likely to do so for many years to come. But Linux and Google have emerged to be a thorn in Microsoft’s side. Both of these alternatives have small market shares. However, both are able to limit Microsoft’s pricing power in some of its markets, especially governmental markets. (See the Symptom & Implication, “The industry leaders are losing share” on StrategyStreet.com.)

Healthcare pricing seems to be out of anyone’s control today. Maybe ObamaCare will fix that, though that is hard to see when, overnight, we increased demand without increasing any supply. It is more likely that healthcare will continue; indeed, even accelerate. But there is an emergent competitor: medical tourism. Ten years ago, few of us would have considered going to a foreign country to undergo an important medical procedure. As recently as 2007, more than 750,000 Americans traveled abroad for a medical procedure. That market is growing at better than 15% a year. And as medical tourism grows, so too will the skills and capabilities resident at the medical facilities these tourists visit. They will become stronger competitors. (See the Symptom & Implication, “Competition is expanding with the appearance of discounters” on StrategyStreet.com.)

Higher education is another area where school participants seem to have virtually unlimited pricing power. Along with that power has come a boom in for-profit college and university alternatives. These for-profit institutions are still a small factor in the market, but they are growing very rapidly. Now DeVry University and the University of Phoenix are unlikely to challenge the Ivy League any time soon. But, eventually, they will put the breaks on the pricing freedom in many of the lesser known public and private institutions.

Paying Attention to Low-End Competitors

When do we have to pay attention to low-end competitors? The cell phone operating system business gives us an indication.

There are a number of cell phone operating systems from which to choose. The major suppliers include Microsoft, Google, Apple, Nokia and Research in Motion. Google is the newest entry here, and is beginning to make waves with its free Android operating system. (See “Audio Tip #33: Strong vs. Weak Competitors” on StrategyStreet.com.)

There are two separate sets of customers for these operating systems. The first, and most important, are the carriers. The four major carriers include AT&T, Verizon, Sprint and TMobile. A secondary set of customers are the handset makers. These companies are secondary because they conform to the demands of the carriers in the U.S. These handset makers include Samsung, LG, Sony Ericsson, Kyocera, Dell, HTC and Apple.

In the cell phone operating system market, Nokia is the leader with its Symbian operating system. Research In Motion, with its operating system for its BlackBerrys, is also strong. The key growth market today is the smart phone market, where Apple has 13% of the market. Apple is gaining market share, at the expense of Windows Mobile, which has managed to hold on to 9% of the market. Google’s Android operating system is on only 2% of the world-wide smart phones. So should the operating system competitors fear Google’s Android? The answer is yes, for a couple of reasons.

The first, and most important, reason is that the largest carriers, all four of them, have agreed to offer Android phones. (See “Audio Tip #29: Positive vs. Negative Volatility” on StrategyStreet.com.) Whenever the largest customers in the market agree to carry a product, that product has to be taken seriously by other competitors. The adoption of Android systems by the top four carriers argues that Android is a serious competitor.

The next reason is that most of the phone set makers have also adopted an Android operating system for some of their phones. Motorola eliminated Windows Mobile in favor of Android. HTC plans for half of its phones to run on Android this year. And Dell is using Android for its market entry. Most of the other competitors, including Samsung, LG, Kyocera and Sony Ericsson are also making Android devices. Apple will not offer an Android phone. So, the secondary customers have also spoken and affirmed that Android is serious.

Once the major customers have endorsed a low-end competitor, that competitor’s impact on the market will be pervasive. Android will not be a low-end competitor for long. Google will use its growth in the market to fund product innovations which will bring its operating system up to the standards of the better players in the market. Further, the growth of the Android system, which is free, will inevitably reduce the volume of sales or the price, and probably both, of the higher end operating systems. A low-end competitor who continues offering low prices while, at the same time, improving its product’s performance will reduce the margins of all other competitors in the industry. Its performance for price proposition will focus customers’ attention on the marginal differences that the higher end operating systems offer for their marginal prices, depressing either sales or prices. (See “Audio Tip #80: Measuring Customer Cost Savings” on StrategyStreet.com.)

Microsoft is Leaving Money on the Table

Every few years, Microsoft introduces a new version of its very popular Office product. The last version was Office 2007. The next will be Office 2010. As often happens with technology upgrade innovations, the new versions sometimes do not offer enough additional benefits to justify all the customers of the old version spending on the upgrade. Office 2003 attracted 60% of the existing Office customers when it came out. Current expectations are for Office 2007 to attract somewhere between 50% and 55% of existing Office users to upgrade. So, somewhere between 40% and 45% of the current Microsoft Office market will not upgrade to the next version.

That is a problem for Microsoft. The company introduces its Office products in a bundled package. The product improvements and upgrades come in packages that contain most of the Office products, with the exception of the Access product. For the most part, Microsoft does not sell the improvements to the Office products as separate, stand-alone products.

Other companies have sensed an opportunity in this Microsoft approach. They have introduced add-on products that give old versions of Office some of the features of current and future Microsoft Office products without the full cost of upgrading. Some of these products include Xobni, DockVerse, Gist and Xiant. Basic versions of some of these products are free, while premium versions come at a modest cost.

These add-on products are low-end competitors. They are examples of Stripper products, one of the four major types of low-end competitors (see the Perspective “Turmoil Below: Confronting Low-End Competition” on StrategyStreet.com). Microsoft is ignoring the success of these small Stripper competitors.

It seems there should be a better path for Microsoft. The company might introduce its own stand-alone version of these products and match their pricing. This move would forestall the growth these Stripper companies enjoy today and provide Microsoft with additional revenues from the 40% of its current customer base who will not upgrade to the new Office 2010 product. If the customers like the Microsoft products as stand-alone add-ons, they may be more likely to upgrade to the new Office 2010 when it comes out.

Aside from the fact that Microsoft is leaving money on the table (see the Perspective “Failure Shifts Shifts More Share than Success” on StrategyStreet.com), it is generally a bad idea to ignore low-end competition that is entering your market.

Microsoft Gets Pricing Warnings from Competitors

Recently, Google announced that it was creating an operating system to work on the new small netbook computers. Netbooks are the only part of the PC market that is growing today. Google hopes to introduce an operating system there in order to serve as a stalking horse to slip into Microsoft’s share with desktop and notebook PCs.

Also, Cisco has let it be known that it was considering offering a rival to Microsoft’s Office software. This service would let business users create documents they could draft and share through Cisco’s WebEx meeting and collaboration service. Google has already attempted to best Microsoft in the Office world with its Google Apps internet-based alternative. Google has yet to create much traction with this product. The outlook for Cisco’s product must wait until it actually appears. But the point here is al the new competition.

Why is Microsoft seeing so much new competition in markets where it is the overwhelming dominant leader? Because its prices are so high. It is drawing competitors into the marketplace who want a piece of Microsoft’s enormous profit base. (See Audio Tip #119: A Price Umbrella on StrategyStreet.com.) These competitive forays are likely to continue as long as Microsoft holds the high price umbrella over them. These new competitors have a mighty mountain to climb, so they might not succeed. On the other hand, one of them just might and create real pain for Microsoft. Linux has already damaged Microsoft in some of the large markets that Microsoft serves. (See Audio Tip #102: When is Price Likely to go Down? on StrategyStreet.com.)

Interestingly, Cisco specifically stated that it was not interested in competing with Salesforce.com in selling online applications for corporate users. You probably wonder why. So did I. Here’s why. Microsoft has the following results on a trailing twelve month basis: Operating Margins 37% and Return on Equity 42%. In contrast, Salesforce.com has these results on a trailing twelve month basis: Operating Margins of 7% and Return on Equity 9%. I guess the price and profit umbrella held up by Salesforce just doesn’t allow even big companies to crawl in underneath.

Microsoft Gets Price Warnings from its Customers

Microsoft is introducing Windows 7 to replace its unpopular Vista operating system. The company is at logger heads with its PC manufacturing customers over pricing for the new software.

Here are two of the problems. First, Microsoft intends to charge $50 for an entry level version of the operating system, called Windows 7 Starter Edition, which is triple the price the company gets for the cheapest version of Windows out now. Microsoft charges between $60 and $150 for Vista today, but the PC manufacturers can use the older Windows XP for roughly $15 for netbooks, the only growing sector of the PC market. If Microsoft raises the price for the cheapest operating system to $50, the PC makers have to raise their prices or lose all the profits they have on the netbooks. Second, Microsoft plans to charge an additional $200 for the Windows 7 Home Premium edition. This additional cost would increase the price of a mid-range PC by 50%, from around $400 to about $600.

The PC customers have seen significant changes in their market. Competition has increased and prices have fallen. The average notebook, the source of most profits in previous years, has seen a price decline of about $800 from $1400 in 2004. The average notebook now costs less than the average desktop.

These PC manufacturer customers have an important message for Microsoft. (See Video #1: The Two Best Consultants in the World on StrategyStreet.com.) They are Microsoft’s key channel of distribution. The customers are telling Microsoft that, if the company charges these prices, sales volumes will fall for both the PC manufacturers and for Microsoft. Microsoft would be well advised to listen to these customers since Microsoft makes a lot more on the average PC than does the PC manufacturer. Microsoft can not, for long, operate at cross purposes with these PC manufacturing customers. High prices to these customers push them to alternative software suppliers. (See Video #7: Constraints on the Ability of Competition to Expand on StrategyStreet.com.)

New Product in a Fast Growing Industry: Bing

After failing more than once to create an innovative and attractive search product, the persistent Microsoft is back with a new entry called Bing. Let’s use the Customer Buying Hierarchy to evaluate the prospect for the Bing’s success.

The Customer Buying Hierarchy (see “Video 27: Full Description of How the Customer Buying Hierarchy Works” on StrategyStreet.com) holds that customers buy a product using four categories of evaluation: Function, Reliability, Convenience and Price. Function (see “Video 13: Definition of Function” on StrategyStreet.com) refers to the features of the product that affect how it is used. Reliability (see “Video 14: Definition of Reliability” on StrategyStreet.com) refers to the benefits of the product that assure the customer that it works and will continue to work. Convenience (see “Video 15: Definition of Convenience” on StrategyStreet.com) refers to the ease with which the customer may find and purchase the product. Price is the cash cost the customer pays for the product.

We will begin with a look at Function differences. The search industry has two customers: The consumer searcher and the advertiser. This new Microsoft entry is drawing some good reviews for consumers and some wait-and-see opinions from advertisers. Bing offers some new Function innovations that reviewers prefer to Google’s search results. It appears that the consumer will find Bing an improvement on Google. The advertisers, however, are adopting a wait-and-see attitude. Google’s market share, at over 60% of the current search market, is massively larger than is Bing or its Microsoft predecessor. Even Yahoo Search is much larger than is Microsoft in the market. Many of these advertisers plan to wait to see whether Bing will become the new Google.

The Reliability and the Convenience advantages in this market belong solely to Google. The company name has become a verb describing a search. Most people know about the Google product and believe it to be the market leader. A large percentage of desk top and lap top computers have the Google toolbar with its search box resident on their computers. Google is an easy default choice for most searchers.

So, what is the outlook for Bing? The success of Bing largely depends on what Google does to respond to the Function advantages Bing is bringing to the market. This is still a fast-growing market. This works in Bing’s favor. Consumers are likely to be willing to try something new if they think it might help. Switching to Bing from Google or Yahoo offers little difficultly. Microsoft has the cash to put on quite a marketing blitz. All of these Convenience factors work in Bing’s favor. However, Microsoft has to rely on the forbearance of competitors in order to win in this marketplace. It has to maintain its unique Functions in order to best Google in a world Google dominates. (See the Perspective, “When to Compete on Features” on StrategyStreet.com.) If Google copies Bing’s new Functions, Bing will lose its advantage and will not succeed. The Reliability and Convenience advantages that Google enjoys today give it time to copy Bing’s Function advantages without losing much of its current market share.

If Google neutralizes Microsoft’s Function advantages soon, Bing will bring only modest market share changes.