Wednesday, August 17, 2011

Google's Motorola Mobility Acquisition and how Apple spends it cash

Google’s US$12.5B purchase of Motorola Mobility is the most eye-catching tech news in the last few days. I’ve read many articles on the web about what this purchase means to various parties, how that would affect the mobile phone industry and all that. I think that’s quite an interesting topic. Regarding what are being said on the street, basically, these are what I read and can remember so far:

The reason of the purchase

- Google is deeply involved in patent war with Apple and Microsoft. As patent has become a key arsenal in this war, with Google’s recent loss in the Nortel patent bid against Apple and MS. Google has to turn to other sources. Motorola is the pioneer in mobile technology with a war-chest of patents. So, it became Google’s target naturally.

- In spite of the surge of Android adoption in the market, Google still felt that it has been short-changed in competition with Apple which has a vertical integration of the whole smartphone industry components. Thus, acquiring a hardware (handset) manufacturer makes sense to Google. Now, Google can directly compete with Apple from end to end. In addition, Google may be able to enjoy both the advantages of having open sourced Android to various smartphone manufacturers as well as having its own, versus Apple which goes alone.

Speculated Effects on the industry:

- Microsoft may be happy that many Motorola’s competitors like LG, Samsung, HTC will devote more resources to ‘hedge the bet’ on Android alone, by producing Window Mobile 7 Phones.

- Motorola’s competitors will still stick with Android for now, but would either push Window 7 phones as MS wishes, or do something on their own. E.g. Samsung is pushing Bada which is a customized Android that would give a different user experience to its users.

- Google will have problem integrating Motorola’s 19,000 staff in house, given its experience of being a search company without prior experience in manufacturing, a lot of things have to learn and can happen.

- Microsoft may be driven to purchase Nokia outright. Also, other manufacturers may become targets themselves, particularly those with many patents, such as RIM.

- RIM is doomed, given the current consolidation and alliances in the smartphone industry. Will it become another Palm?

- Google will also gain on the TV front, given Motorola’s prominent status in TV set top boxes. So, Apple TV would be under pressure somehow.

Etc.

Well, I think those speculations are, by no mean that, have certain validity. What I would want to say is that this acquisition wouldn’t have much impact on Apple, at least, not from the strategy planning of its development. $12.5 B is not a small amount though Google has a lot of cash on hand. I don’t think that would push Apple to make its own giant acquisition deal to top Google’s. I do admire Android and really like Chrome myself. I do use many Google services, such as youTube, Blogger, Document, Gmail, Earth, etc. I also like Google search much more than Bing. However, I still don’t see Google’s current development strategy on par with Apple’s.

Apple’s current development strategy is all about providing the best user ‘experience’ as possible. Apple is doing it my creating its own ecosystem, tries to control every components down to a key stroke or nuts and bolts. It owns its software, the IOS, and MacOS. They are protected and controlled totally in house. It designs its products. From the material being used, the chip, the form factor, the color, even is tempting to create its own type of screws in upcoming products. They just want its product to be not just working, but also cool to own and fun to use. Then, it creates its own stores. The physical ones are with top notch interior design with lots of glasses, black and white benches that display products for customers to play with and its friendly experienced staff can really help users on the spot. Then, it has virtual stores of iTunes/App stores, and Mac App Stores, which have been very effective distribution channels. iTunes is top music store in the world. It collection of podcasts and courses on iTunes U are unparallel. The App stores set the trend in the industry and its sister spin-off of Mac App Stores also strike the core of users. Apple has a line of products that are highly distinguishable from its competitors and it can charge premiums. Also, Apple has the mystic power of its iconic leader Steve Jobs, the aura of Apple being a brand used by cool people like artists and musicians for decades on top of the top advertising dollars it spends, the brand of Apple has still been able to stay cool so far in spite of its widely adoptions by many regular Johns and Janes is simply amazing! I couldn’t think of any other company could generate that amount of buzz for its upcoming products or even some ‘unicorn’ products that never exists. That kind of rumors, reports, speculations in the media are free ads that Apple doesn’t pay a dime for, certainly invite envy from most companies. iPhone 5 and iPad 3 are what people are talking about. Apple chooses not to release a lot of products, that makes it easier to control its quality and keeps customers’ focus, rather than releasing so many similar products with forgettable names. That’s why, to me, I still see Google is playing the catch-up role, though it is much better than MS which is still a bit clueless and chaotic. I would wish Google can march its own alternative development from Apple but as good as Apple.

While Google spending a fortune on this acquisition, that reminds me of an article that I want to share with readers. The title of the article has been changed as times goes by. It is about how Apple spends its cash. Since its cash amount has kept on growing, the latest title is that…

“What would be a good use of Apple's $76.2+ billion in cash?”

This is what he (Anon User) said:

Apple actually uses its cash hoard in a very interesting way to maintain a decisive advantage over its rivals:

When new component technologies (touchscreens, chips, LED displays) first come out, they are very expensive to produce, and building a factory that can produce them in mass quantities is even more expensive. Oftentimes, the upfront capital expenditure can be so huge and the margins are small enough (and shrink over time as the component is rapidly commoditized) that the companies who would build these factories cannot raise sufficient investment capital to cover the costs.

What Apple does is use its cash hoard to pay for the construction cost (or a significant fraction of it) of the factory in exchange for exclusive rights to the output production of the factory for a set period of time (maybe 6 - 36 months), and then for a discounted rate afterwards. This yields two advantages:

Apple has access to new component technology months or years before its rivals. This allows it to release groundbreaking products that are actually impossible to duplicate. Remember how for up to a year or so after the introduction of the iPhone, none of the would-be iPhone clones could even get a capacitive touchscreen to work as well as the iPhone's? It wasn't just the software - Apple simply has access to new components earlier, before anyone else in the world can gain access to it in mass quantities to make a consumer device. One extraordinary example of this is the aluminum machining technology used to make Apple's laptops - this remains a trade secret that Apple continues to have exclusive access to and allows them to make laptops with (for now) unsurpassed strength and lightness.

Eventually its competitors catch up in component production technology, but by then Apple has their arrangement in place whereby it can source those parts at a lower cost due to the discounted rate they have negotiated with the (now) most-experienced and skilled provider of those parts - who has probably also brought his production costs down too. This discount is also potentially subsidized by its competitors buying those same parts from that provider - the part is now commoditized so the factory is allowed to produce them for all buyers, but Apple gets special pricing.

Apple is not just crushing its rivals through superiority in design, Steve Jobs's deep experience in hardware mass production (early Apple, NeXT) has been brought to bear in creating an unrivaled exclusive supply chain of advanced technology literally years ahead of anyone else on the planet. If it feels like new Apple products appear futuristic, it is because Apple really is sending back technology from the future.

Once those technologies (or more accurately, their mass production techniques) become sufficiently commoditized, Apple is then able to compete effectively on cost and undercut rivals. It's a myth that Apple only makes premium products - it makes them all right, but that is because they are literally more advanced than anything else (i.e. the price premium is not just for design), and once the product line is no longer premium, they are produced more cheaply than competitor equivalents, yielding higher margins, more cash, which results in more ability to continue the cycle.

Some readers comments on this article with some insightful views as well, such as this one from Alston Ho:

By not buying the plants out outright but instead assisting the plants, Apple shifts the operations and management to the people who understand that new component the best as well as that component's suppliers as well as the labor force and political locality. The company can then focus on its strategy of designing the new products rather than designing the new products and all the new components that go inside of it. By doing so Apple gains these additional benefits as well:

1) Company focuses on its core competency and out-tasks the periphery.

2) Company deploys less capital and has less capital at stake than fully buying it outright, allowing them to accumulate more cash and generating more ROIC.

3) Company gains additional teeth in the way their suppliers operate, reducing this element of uncertainty.

4) Technology and its rapid pace of innovation has an element of creative formation and destruction. Apple has to be able to design and incorporate and source and integrate a component into their products, then subsequently/simultaneously moving away from it onto something new.

I think the author of the top article has a very in-depth view on Apple’s development strategy. I also find his view make a lot of sense and actually ties to reality.

From Wikipedia, you can see what kind of enterprise does Apple buy?

For example:

1997 Next (programming services). Value: $404 million

1997 Power Computing (cloned computers). $100 million

1999 Xemplar Education (software). $5 million

1999 Raycer Graphics (graphic chips). $15 million

2000 NetSelector (Internet software). Value: NA

2001 Astarte (DVD authoring software). Value: NA

2001 bluebuzz (Internet service provider). Value: NA

2001 Source Technologies (graphics software). Value: NA

2001 PowerSchool (online info systems services). $62 million

2002 Nothing Real (special effects software). $15 million

2002 Zayante (software). $13 million

2002 Silicon Grail Corp-Chalice (digital effects software). Value: NA

2002 Emagic (music production software). $30 million

2002 Propel Software (software). Value: NA

2005 Fingerworks (gesture recognition). Value: NA

2006 Silicon Color (software). Value: NA

2006 Proximity (software). Value: NA

2008 P.A. Semi (semiconductors). $268 million

2009 Placebase (maps). Value: NA

2009 Lala (music streaming). $17 million

2010 Quattro (mobile advertising). $275 million

2010 Intrinsity (semiconductors). $121 million

2010 Siri (software). Value: NA

2010 Poly9 (Web-based mapping). Value: NA

2011 Share in the Nortel purchase, Value: $2.6 Billion

See? Not a Facebook or Disney among them. And the largest acquisition -- by far -- was the 1997 purchase of NeXT that brought Steve Jobs back to Apple.

Reported by Appleinsider.com on Jan 18, 2011, Apple's chief operations executive Tim Cook revealed that the company had entered into long term component supply contracts worth $3.9 billion over the next two years.

The article said:

Cook noted that the secret deals were a "fantastic" use of the company's cash reserves, which have now grown into a $59.7 billion stockpile.

When asked what components were involved in those long term commitments, Cook answered, "I don't want to give it out, because I view it as a competitive… something I don't want our competition knowing."

Cook references A4, RAM as examples

Cook added, "Let me talk in general. From our point of view on design side, we design components where we believe we can innovate beyond the market. Most recent example, A4 chip. With the A4 chip, we didn't think we had to invest in a fab [chip manufacturing facilities], so we focused on design."

"On the operational side of house," Cook stated, "we've historically entered into agreements with others to supply; largest one was with flash memory suppliers back in 2005 that totaled over a $1 billion, because flash would become increasingly import across product line and industry."

Apple is now the world's largest consumer of memory chips, in large part because it bundled large amounts of flash RAM in its iPods, and subsequently introduced the iPhone with far more memory storage than other smartphones, beginning with 4 to 8GB on the original iPhone at a time when most smartphones shipped with 256 to 512MB of storage.

"We think that was an absolutely fantastic use of Apple's cash," Cook said of the company's decision to pre-purchase a billion dollars of flash RAM, "and we constantly look for more of these. In the past several quarters, we've identified another area and come to recent agreements."

Nearly $4 billion of component strategy

Cook described the deal as "similar to flash agreement, focused in an area that we feel is very strategic," but said he would "prefer not to go into more details about what specific area it's in, but it's the same kind of thinking that led us to those deals."

Cook had earlier discussed the generally favorable pricing environment for components that had reduced the company's costs in the quarter more than expected, and noted that going forward one could "expect a favorable pricing environment for DRAM," while "some prices for raw materials such as key metals are currently increasing due to anticipated strengthening of worldwide economy. Bulk of other commodities from NAND to LCDs to batteries and most others are generally in supply/demand balance."

Components that may be considered strategic enough to warrant a $4 billion advanced commitment may include the rumored very high resolution Retina Display anticipated for iPad 2, or may relate to the custom design technology Cook discussed regarding the A4, such as component supply capacity for the coming A4 replacement, Apple's custom battery designs, or a combination of commodity parts, custom fabrication or Apple's original chip designs, and state of the art components.

So, I guess Apple’s 2011 purchase of Nortel shares is more for the patent war, I don’t think it would be a start of change of its all along strategy, as paraphrasing BusinessWeek's Arik Hesseldahl: "Apple's business philosophy is to acquire small companies that can be easily integrated into existing company projects." The Nortel purchase may just be an exception after all.

Well, we will see…

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