Understanding The "Network Effect" In The Mobile Platform War

Who’s going to win the mobile platform wars? Why? How? 

We think Apple is doing better than most observers realise, Android isn’t, and Microsoft is underestimated. Read on to find out why…

What The “Network Effect” Is And Why It Matters

Global Smartphone Market Share By OS, iOS vs. AndroidAndroid is crushing Apple when it comes to market share (Click to enlarge)

Photo: Gartner

Even though Apple gets tons of profit from its mobile operating system and Google gets probably none, people in the industry fret about market share, not just revenue and profit share. The reason for that is that the mobile wars are platform wars, because mobile operating systems are software platforms. And the reason why it matters that this is a platform war is because platforms are understood to have network effects. Network effects are what happen when a product becomes more valuable the more people use it. 

If this network effect happens when it comes to mobile platforms, then it matters a lot that Android is crushing iOS in marketshare, even though it makes no money, because it suggests that at some point, Android’s network effect will make iOS irrelevant, just as Windows made the Mac irrelevant, and all those profits will vanish (or, at least, shrink dramatically). 

Which Network Effect Counts

iOS is a much better revenue generator than Android (Click to enlarge)

Photo: Flurry Analytics

This reasoning is wrong, or at least much too simplistic. The reason for that is that when it comes to software platform, what creates a network effect is not the end users but the developers. (Microsoft, the historic platform company, knows this well, of course.)Unlike, say, the phone network, where the value of the network is a first-order derivative of the number of end users, for a software platform, the number of end users is a second derivative. The first-order derivative is the value of the software on the platform. End users tend to buy the platform that has the most software, and so it’s the software that creates the famed network effect virtuous cycle. 

Obviously, developers will tend, all else being equal, to go with the platform that has the most users, but a key thing to note is that it’s the developers, not the users, that matter. The users go where the developers go.

The other key thing to note is that in mobile not all else is equal, and that this has very important implications for the mobile war. 

What isn’t equal is that, from all the data we’ve seen, developers make software for iOS first, iOS has more developers and iOS is more profitable for developers. 

According to data from mobile analytics firm Flurry, while iOS is way behind in end user market share, it is way ahead in developer market share, the type of market share that matters most. 

For a variety of reasons that have to do with the Apple App Store’s better design and the ease of paying, cross-platform developers generate only 24 cents in revenue from Android for each dollar they generate from iOS (see chart above). 

And, even more worrying for Android, the trend doesn’t seem to be reversing. You might think revenue would be a lagging indicator of developer interest in the platform, as iOS developers transition to Android to chase Android’s enormous userbase. But Flurry’s data doesn’t show that: over 70% of new mobile app projects are on iOS, a share that’s held steady for the last three quarters of 2011:

New Project Starts, iOS vs. AndroidDevelopers still love iOS more than Android (Click to enlarge)

Photo: Flurry Analytics

The Right Analogy For The Mobile Platform War

console warsA look at seven generations of console wars (Click to enlarge)

Photo: techblog.cosmobc.com

The entire discussion around the mobile platform war revolves on a historical analogy: the PC market. Partly because smartphones are the next big computing platform, so it’s natural to look at what happened last time a big computing platform took over the world, and partly because there’s a poetic aspect to it: last time Microsoft crushed Apple, and now Apple is crushing Microsoft (or perhaps Apple is getting crushed again for making the same mistakes as last time). But we would actually argue that a more apt historical example are the games consoles wars. Like other software platforms, gaming consoles have network effects. 

Here are some other similarities between mobile platforms and games consoles:

  • The terminals are subsidized. Console makers sell them at or below cost to entice sales of the software. (Apple doesn’t subsidise its phones, but the carriers do.)
  • Developers give a pound of flesh, and don’t control distribution. Apple and Google take a cut of paid revenue, and also ad revenue through their ad networks. They control distribution through their stores. Similarly, games companies pay a cut of console revenue to the conole maker, and though it’s not the platform owner who controls distribution (for most of gaming history, retail stores), it’s not the developers either. 
  • They are truly “personal” computing devices. The PC, paradoxically, may be the least “personal” computing device. For smartphones and consoles, the purchase decision isn’t simply a cold calculation based on a tradeoff between price, performance, functionality, etc. as it is for most PC purchases. There is also an emotional, or at least personal element: you don’t care if the Xbox is the “best” console if you prefer Wii games, and you care a lot what your iPhone or Samsung Galaxy looks like when you pull it out at a party. But when you decide between Dell or HP, the main thing that matters is the most specs for the lowest cost. 

Why does it make sense to look at the consoles wars and not the PC war? First of all, because there’s more data to go by—with each new console generation, there’s a new war. But most importantly, because the consoles markets have rarely been winner-take-all.

Let’s look at the most recent ones:

  • Third generation: (Nintendo Entertainment System) Winner take all, mostly because Atari was teetering on the edge of bankruptcy after a marketwise crash when Nintendo entered.
  • Fourth generation: (SNES, Sega Genesis) Two winners. Nintendo and Sega both built great businesses, without killing each other. 
  • Fifth generation: (Sony PlayStation, Nintendo 64, Sega Saturn) Winner take all. Sony introduced a better technology (CD-based games), early and with better marketing (to teens, not just kids as before) and rolled it up. Sega nearly died and Nintendo barely hung on to a profitable market position.
  • Sixth generation: (Sega Dreamcast, Sony PlayStation 2, Microsoft Xbox, Nintendo GameCube) Three winners. Sony wins and Sega dies, but Microsoft and Nintendo both build great, sustainable platforms.
  • Seventh generation: (Microsoft Xbox 360, Sony PlayStation 3, Nintendo Wii) Winner take most. Nintendo grabs most of the market with its innovative Wii, Sony stumbles with a lackluster product, but Microsoft’s Xbox 360 still does really well despite Nintendo’s dominance.

What do those stories of network-effect software platforms tell us? It tells us we’re very likely NOT seeing a replay of the PC market with Google in the role of Microsoft copying Apple fast only to crush it, as many observers seem to think. 

Instead, we’re seeing a situation similar to the console wars, where there may or may not be a single leading platform, but there is also room for a strong, sustainable number two and perhaps also a third player. 

It also tells us that Microsoft has a better shot in this market than most believe. In video games too it came in late and was dismissed by the incumbents, and yet still built an excellent business there. Microsoft has lots of money, understands software platforms as well as any other company, and great distribution through its partner Nokia. 

Summing up, what have we learned?

THE BOTTOM LINE

  • What creates a favourable network effect in a software platform is developer share, not end user share.
  • While Android is winning in end user share, Apple is most definitely winning in developer share. This means Apple is in a (much) better position than user market share numbers alone indicate.
  • Microsoft is underestimated.
  • We are not probably not seeing a replay of the PC market with a winner-take-all outcome, but a situation analogous to the games console market, with two or possibly three winners. 

MORE ABOUT SMARTPHONES: Our Smartphone Market Forecast →

MORE ON NETWORK EFFECTS: Why Online Network Effects Aren’t All They’re Cracked Up To Be →

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