Apple and Google: Why Current Market Share Results Don't Matter Yet, Part 2 - Forbes

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Five Reasons Why Google Android versus Apple iOS Market Share Numbers Don't Matter. Darcy Travlos Contributor

In August, after Q2 2012 market share numbers for smartphones were released, I wrote Five Reasons Why Google Android versus Apple iOS Market Share Numbers Don’t Matter.  I had three conclusions.  First, for investors, market share may be less important than profitability since, after all, investors are buying a share of a company’s earnings. Second, market share ranking in any one quarter could be distorted by anticipation of upcoming product announcements primarily, as well as carrier promotions.  Third, Apple remains an attractive investment given its earnings expectations to its stock price and outsized cash balance that could enable it to buy market share if it so decided.

The smartphone market has two other important dynamics aside from Apple versus Google that investors should keep in mind.  The market continues to grow, and these two companies are taking market share from the old guard at a shocking pace.  In August, Apple iOS plus Google Android made up 82.9% of the market while Nokia and Research in Motion combined lost 21.7% from the year prior.  The  glaring market share loss of Nokia and Research in Motion, previously market share leaders, was the most striking result.  They lost an additional 2.5% points in this most recent quarter.  The strategies that Apple and Google are pursuing are winning.

Henry Blodget of Business Insider recently wrote a very good counter argument, This Trend is Very Worrisome for Apple.   In his article, he contends that market share does matter because it will eventually impact profitability.  He writes, “The reason market share is important is that mobile is a ‘platform market.’  In platform markets, third-party companies build products and services on top of other companies’ platforms. As they do, the underlying platforms become more valuable and have greater customer lock-in.”  If you haven’t read this article, it is a strong counter-argument; however, I maintain that Apple will maintain or grow its market share in smartphones and Apple’s profitability will remain in tact for the long term (acknowledging short term adjustments with new product introductions.)

Apple is not, at first cut, just a platform company.   A platform company would have third party development as its primary goal.  In its most recent 10-K, Apple defines its business as this:  “The Company designs, manufactures and markets mobile communication and media devices, personal computers, and portable digital music players, and sells a variety of related software, services, peripherals, networking solutions and third-party digital content and applications.”  Apple sells products to create a delightful user experience and that experience is a combination is created through a combination hardware, software and services that Apple designs.  Apple first mentions “platform” as a secondary part of its strategy to “expand its platform for the discovery and delivery of third party content.”

In fact, Apple remains fairly closed with products and arguably for critical applications as well.  The iPhone was introduced by Steve Jobs as a Communicator + Music + Internet Connection.  Apple controlled these applications central to the services it delivered.  One could argue Apple has been open only for games and other add-on applications.  (Case in point:  Apple may not have realized the extent to which Maps and Search mattered, and now it seems like Apple is in process of shutting that “third party” down and bringing that in-house as well.)  Apple does create a platform for developers for these other apps and for enterprise apps, and it has been a boon to mobile developers, with more than $6.5B paid out to them.  But it has not been a significant part of Apple’s business.  To put it in context, Apple introduced the iPhone in 2007, pays developers 70% of the app price, so that means that Apple earned $9.3B in revenues from apps over 5 years, or 2% of the revenue earned over that period.  Most would agree that Apple is an integrated product-software-services company, and most would agree that Apple has not been an “open source” platform company.

Google, on the other hand, is an open source platform company.  As of its last 10-K, 96% of its revenue came from third parties advertising to sell their stuff to consumers.  Their mission:  “Google is a global technology leader focused on improving the ways people connect with information…Our Mission is to organize the world’s information and make it universally accessible and useful.”  Note, Google’s mission is about “open” sourcing, and does not mention products.  These two companies thrive with different tacts.

And, can a platform without the other hooks be profitable?  Java, arguably one of the most pervasive and successful platforms in technology, was not well monetized and not a great for investors.  Java, created and owned by Sun MicroSystems, generated $220M at the time Sun was acquired by Oracle.  That is because Sun did not wrap a monetization strategy around Java.  So, are Google and Apple successful because of the platform or because of the services and products around that platform?

I would phrase their basis of competition differently â€" Apple and Google are both creating ecosystems from different vantage points.  Apple showed the world, and its competition, how to create ecosystems (or services) around content.  Apple innovated and integrated hardware and software, partnered with content companies, to create delightful user experiences, first around music.  It was disruptive.  And it is the first time that technology companies had integrated all three, and addressing a consumer market.  Competition followed suit.  Google hasn’t (yet) successfully innovated a new disruptive ecosystem around content in this market that Apple didn’t pioneer.  (Google tv did not hit stride.)  That said, Google is the best of the competition at replicating Apple integrated hardware-software-services and content strategy, with Amazon coming up next in line.  And while history has shown us what competition will do to margins in an increasingly commoditized hardware category, this is a new type of cycle where margins have held up for Apple despite competition.

Second, the market share numbers can be interpreted differently.   In the Q3 2012, Android again led market share vis-à-vis Apple iOS.   Remember, still, many were waiting for the iPhone 5 to be released, and many who waited could not buy it in the last week of the quarter because Apple experienced supply constraints upon its launch.  For the US statistics, what is noteworthy about those numbers is that despite potential pent-up demand for an iPhone 5 and also for a price-reduced iPhone 4S, Apple iOS gained 1.9 points to Google Android’s 0.9 point gain.  The other glaring point is the continued demise of everyone else.

And that trend plays out internationally too.  Worldwide, Blodget points out that the combined Apple iOS â€" Google Android market share is similarly 90% although the differential between Android and iOS is greater, as he points out that  Apple’s iPhones are too expensive in many parts of the world, namely India and China.   He argues that if Apple does not change its product strategy, it will lose market share.  However, Apple’s market share in the US has increased from 25% to 34% over the past two years.  It could be argued that this trend of growing market share could play out internationally as well, particularly given Apple’s success in China.  iPhones are the top-selling high-priced phones in China according to IDC, although currently they are only available at China Unicom and China Telecom, the second and third largest carriers in China.  Apple is expected to rollout the iPhone 5 in at China Unicom and China Telecom in December.  Apple is also rumored to introduce an iPhone 5 in conjunction with Qualcomm for China Mobile, the world’s largest carrier with close to 700M subscribers.  With the market size of China and the panache of Apple products in China, Apple may be able to improve market share internationally as it did in the US.

Third, mobile app developers still prefer to develop for Apple iOS for two reasons.  They get paid and it is easier.  To date, Apple reported that it has paid $6.5B to developers because more of the iOS apps are sold on iTunes while more of the Android apps are free.  It is harder to develop to Android, not just because of the many forms of Android, but also because of the many different hardware devices that run Android.  Apps are considered “really cool” when they take advantage of the inherent hardware componentry, such as sensors and touch screens, that can vary among hardware devices.  Creating applications that can take advantage of these is a big task with hundreds of different devices running Android whereas the number of hardware devices operating Apple iOS is limited to three phones and three iPads, with similar components.

Michael Porter, the Harvard Business School competitive strategy guru, popularized the concept of “Stuck in the Middle.”   To very briefly summarize a component of his theories, companies may be very successful focusing on differentiated, innovative strategy and be profitable in this “niche.” And companies may be very successful and profitable pursuing a broad market, low-cost strategy.  But “being stuck in the middle” is when companies, simply put, try to be all things to all people.  Apple and Google, in many ways, have successfully carved out successful strategies as evidenced by profits (Apple, 30.4% operating margin reported last quarter) and pervasiveness and profits (Google, 19.4% operating margin reported last quarter).  Death comes to those trying to flank at every market segment, resulting in too many products, consumer confusion, and brand dilution (Nokia -8.0%, Research in Motion -12.6% operating margins reported last quarter).  Google stays above the fray by providing Android, but will need to stay within a market segment with its new phones, tablets and Motorola products; Apple has stayed at the premium and innovative end of the market.  It would be a mistake for Apple to compete at the low end, for the above-cited reasons of lack of product focus, consumer confusion and brand dilution, just to gain market share when it, to date, still innovates and has brand loyalty to keep its profitability in tact.

Regardless, the real point is that both Apple and Google are achieving success at the expense of the old guard.  Both have well-defined strategies, and both are executing well.  And, both are undervalued today.   Consider the following valuation metrics of Apple and Google, compared to Amazon (a tech darling), Caterpillar (representing the industrial sector), Exxon (representing the energy sector) and Walmart (representing mass retailing).  Both Nokia and Research in Motion have expected earnings losses.  And Price Earnings to Growth, or PEG, represents how much it costs to “buy” growth, so that PEGs below 1.0 are considered attractive and PEGs below 2.0 are considered attractive for growth companies.  By these standards, both Apple and Google are attractive at today’s stock prices.

Near term fluctuations in market share will not matter between Google and Apple for some time.  Both strategies can co-exist and actually reinforce each other.  As Apple innovates on the high end and Google can provide Android to enable others to replicate some of Apple’s feature set at various price points.  And, Apple’s “niche” market share (25% for smartphones, 68% for tablets) at high margins in growing markets isn’t worth dismissing quite yet, particularly at these valuations and growth trajectories.  Investors are well served today to focus on the success and future of each of these strategies at the expense of previous competitors, particularly while these markets are still growing.