What Happens When Hardware Makers Can Make No Profit

It is starting to be quite apparent that smartphone OEMs will no longer be able to earn profits. Ben Bajarin put together an excellent piece (paid article) on this in which he questions;

What is the “product” in the Android ecosystem? Specifically where are the revenue generating opportunities? As the answer inevitably becomes “not hardware”, the product offered must evolve. This is where the basis of competition will shift in the Android ecosystem. This shift will disrupt incumbents and open the doors to new entrants.

This is a typical case of what Clayton Christensen has called “The Law of Conservation of Attractive Profits”. I have described this previously in this blog.

As technology progresses and solves the most pressing problems in smartphones, the profits move away from the hardware assemblers to adjacent stages. Hence the predicament that Samsung now finds itself in. At this point however, it is not yet clear which adjacent stages will reap the profits. In particular, it should stress that is no by no means obvious whether Google services will become this stage or not.

Benedict Evans has also written about this on his blog.

It seems pretty clear now that the Android OEM world is starting to play out pretty much like the PC world. The industry has become unbundled vertically between components, devices, operating system and application software & services. The components are commoditised and OEMs cannot differentiate on software, so they are entering a race to the bottom of cheaper and cheaper and more and more commoditised products, much like the PC industry.

So what we are seeing can be summarized as follows;

  1. Hardware is no longer a profit generating opportunity in the Android ecosystem.
  2. Attractive profits will shift to adjacent stages in the value chain.
  3. We have seen something similar happen before in the PC industry.

Therefore, in order to understand how the Android ecosystem will evolve, it is important to revisit the history of the PC industry and to review what happened when profits could no longer be made in hardware.

There are actually quite a few independent things that happened. Here I would like to highlight “crapware”.

Crapware

Ken Segall describes the situation beautifully;

“Crapware: the search for lost profit”

It was only about three years ago that I attended an advertising meeting with the chief marketer in Dell’s consumer division. He had crafted his plan to meet sales targets for the coming year.

At the proper point in the meeting, Mr. Marketer made mention of the crapware on Dell computers. And yes, he called it crapware. He pointed out that margins being what they were, crapware actually accounted for just about all the profit on each sale. He invited the agency to come up with new suggestions for companies who might want to join the club — and pay Dell for the right to clutter up their PCs just a little more.

What’s a smartphone seller to do? Crapware to the rescue!

Mike Jennings reports his crapware findings for PC Pro. In a wide range of Android phones, he found a treasure trove of crapware installed by carriers: multiple app stores, security software, game demos, etc., etc. While you can remove this stuff from PCs with a little effort, not so with smartphones. Most of it is here to stay, installed in such a way that it can’t be removed by the user.

Quite simply, if hardware makers (or carriers) can no longer make profit, crapware will proliferate. Since the attractive profits have moved to the crapware owners, they will be willing to pay to have their stuff put in front of customers.