How ATT and Verizon turned mobile software into the new growth industry

Yesterday, I had the misery of replacing of my phone.

When I originally bought my Nokia cell phone, I bought it with the expectation that I would get an early upgrade in about a year. Given that the phone was free – thanks to a bug in the OS – the theory was that in one year I would buy a better phone at a reasonably discounted price to replace my aging and dying Nokia E71

Except ATT, and now Verizon, changed the rules of the game and the early discount no longer applied.

Which sucked for me… but it really sucks if you are hardware manufacturer…

In the hardware business, you really need to get people to upgrade to the next model to make money. If they don’t upgrade, then you make less money. It’s really that simple.

Storage as a hardware business is awesome because storage is like a consumable… as long as you are creating data you are buying more storage. Once you use storage it’s no longer re-usable for another purpose without deleting data and data never gets deleted.

But to upgrade to a new cell phone you need a compelling value proposition at a reasonable price.

With the early discount model the carriers had turned what could have been a two-year upgrade cycle into a one year upgrade cycle. And had allowed more share of wallet to go from software vendors to hardware vendors… Folks who could spend were spending more on hardware over two years than on software.

The carriers have now reversed that policy which means that the prices after one year have gone up.

This is really unfortunate for hardware manufacturers. To deal with the sudden increase in price, hardware vendors must either make the product more valuable through faster innovation, or figure out how to make the hardware cheaper or accept slower growth.

Changing the rate of innovation is hard. In fact, I would almost argue is impossible. Hardware rate of innovation is ultimately tied to Moore’s law. So you have to cut prices which is also sucks because it affects margins. Or you accept slower growth which isn’t so bad … other than the part where your shareholders ask you to do things like hand over your cash hoard and demand a dividend … and let’s not get into the employee retention thing.

All this means less profit for hardware vendors which means less innovation etc…

A slower hardware innovation adoption rate, however, is fantastic for software vendors. Unlike hardware, software vendors are able to continuously add value to devices without an upgrade cycle. In addition,for subscription services as long as the vendor adds incremental value the average sales price doesn’t have to drop …

So what does this mean?

If you consider the amount of money that the median first world person has as fixed or slightly declining over the next 10 years, then software vendors can capture a bigger share of the wallet.

Let’s be very specific:

Suppose a customer is will to spend 600$ very two years on a phone. In the old world, the customer could buy a 200$ one year, and a 400$ the next. With the new policies the customer spends 200$ and 600$ the next year because there is no discount. So the customer – unless he sees a compelling value proposition decides to not buy the 600$ phone which frees up 400$. That 400$ is available to spend on incremental software services on his phone. Although it’s certainly true that not all that money will go to software, but some of it will. And the really cool piece of news is that folks who were buying early upgrades have enough disposable income to actually want to buy more software services to extend the value of the device they already own.

If I was a software service vendor like Evernote or Google or Microsoft this is the best piece of news I have heard in a very long time… More money to spend on services.

If I was a hardware vendor this would suck. And the market agrees which explains the collapse of Apple shares.

And if I was Microsoft trying to grow my platform this would also suck because

  1. It means that growth of Windows Mobile will be slower as it takes longer for people to buy new phones.
  2. Given the investment consumers are making  in services, the stickiness of  incumbent platforms may increase over time.

My only hope if I am Microsoft is that they can somehow create faster software innovation that motivates people in the next upgrade cycle to switch … This is possible … in principle (bing is number #1 in search – right?) … 

And if I was blackberry, I would pray there were a lot of people who loved me…

And if I was anyone else trying to build a cell phone platform, I might be looking for a new strategy…

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