As the world recovers from its delirious response to the Google Phone, analysts are weighing in on the financial and strategic implications.
Here are two big issues the company will need to resolve:
- How to make and sell a hardware device without annoying Android hardware partners. Google will now be competing directly with the folks it is trying to partner up with. The Google Phone, for example, has now completely stolen the thunder of Verizon’s “Droid,” which Verizon is still spending hundreds of millions of dollars marketing. In the past, manufacturers have either sold integrated hardware and software (Apple) or software OR hardware (Microsoft/Dell). Google is trying to have it both ways.
- How to make the device affordable (i.e., subsidized) without wrecking Google’s profit margins. Carriers subsidise phones to the tune of $200-$400 in exchange for a two-year contract. Without a subsidy, Google’s phone would have to be priced around $400-$500 for the company not to lose money, and if it’s priced that high, no one but a few freaks will buy it. If Google subsidizes the phone, meanwhile, its margins will take a big hit–and it won’t get a two year contract in exchange (the “payback” for Google will be increased search usage. But how can you force someone to use the search engine for two years?). Will the carriers still pay the subsidy in exchange for a contract?
Bottom line, still some big questions the company needs to answer.
Below, Imran Khan and Doug Anmuth weigh in:
Imran Khan, JP Morgan:
The Wall Street Journal is reporting that Google plans to sell its own wireless handset in 2010 without a wireless carrier. According to the article, HTC will be the manufacturer, and the operating system will be Google’s Android. Our takeaways:
- Google is trying to drive paid clicks growth. Google’s aggregated paid clicks growth rate decelerated from 52% Y/Y in Q1’07 to 14% Y/Y in Q3’09. We believe that one of the biggest drivers for paid click growth is search query volume growth. We think the proliferation of the Google mobile operating system enabled devices will help Google to drive the query volume and paid clicks.
- Monetization Opportunity. We believe that mobile search advertising will command higher unit pricing (i.e. average price per click) as Google will have better information to provide more relevant advertising. However, we should also note that the mobile screen is not conducive to showing multiple advertisements (screen is much smaller compared to PC screen) and as such we think search associated with mobile will have less coverage which could have a negative impact on click through rates.
- Tough market to penetrate. There are established players with scale and strong domain expertise. While Google has strong brand recognition among consumers, we still believe that it will be a tough market in which to gain market share. For example, despite positive press coverage, Palm Pre is still struggling to gain market share. Additionally Verizon’s Droid phone did not have a material impact yet (We recognise that it is probably too early to draw conclusions). We also think the App ecosystem is a critical component to be successful and AAPL is significantly ahead of the competition.
- Potential negative impact to margins. While, long term, it could help revenue and profitability, we are concerned that it can impact the margins in the near term. Our Apple analyst, Mark Moskowitz, estimates that iPhone gross margins are approximately 65% with a carrier subsidy. We think if Google wants to make the phone price competitive with the current market then its gross margins will be approximately in the 30%-40% range.
Doug Anmuth, Barclays:
On Saturday Google announced via its mobile blog that it is testing a new mobile device running the latest version of its Android operating system. According to multiple press reports, Google plans to sell this phone, named Nexus One, directly to consumers in 2010.
- While few details are available, we believe HTC is manufacturing the device & Google has been more involved in developing the software & hardware than with any other Android device.
- Google’s increased involvement suggests to us that it wants to accelerate the adoption of Android beyond current devices & this could be Google’s answer to taking more direct control over the implementation of the software stack.
- Should Google sell an unlocked device directly to users we believe some of the risks could include: 1) potential payment of device subsidies; 2) conflict with current partners; and 3) lack of carrier distribution.
- We believe this issue is important to investors because potential phone subsidies could impact Google’s overall cost structure. We believe the industry subsidy per device is typically $200-$300 and is usually paid by the carriers.
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