Profits may elude mobile challengers

31 May, 2012

The revolution in consumer electronics touched off by Apple is bringing some unlikely names to the fore in the business of phones and other hardware. But the chance that the newcomers will have any better luck than the old guard that is now in retreat still looks like a long shot.

Google's completion of its Motorola Mobility purchase, and Research In Motion's disclosure that it has hired bankers to consider its financial options are the latest headlines to underline this change.

The names that once led the upper end of the handset business have been eclipsed with remarkable speed in the five years since the arrival of the iPhone. RIM, Motorola and Nokia, which is burning cash fast, have shown how inhospitable the hardware world can be when changing fashions and falling volumes expose the high fixed costs of the incumbents.

The new kids on the block bear unlikely names: Google, Amazon and, showing sporadic signs of interest, Microsoft. Facebook is at an earlier stage in its development as it looks to follow its users beyond the PC, but if persistent reports of a "Facebook phone" are anything to go by, it could eventually follow.

There is a lot to play for. Tim Cook, chief executive of Apple, said at the AllThingsD conference in California earlier this week that the field is still open as annual smartphone sales rise to 1bn within the next three years (compared to under 500m last year). Whether any of the newcomers can match up to Apple – particularly in tablets – is another matter.

Apple has disproved the old truism that profit margins in consumer electronics hardware need be meagre. At nearly 40 per cent, its operating margin is almost identical to those of Google and Microsoft.

However, that does not mean that level of profitability will be available to all. While Amazon is happy to live on very slim margins as it tries to extend the Kindle into the tablet market, it is hard to believe the same is true of Google as its executives insist through gritted teeth that they are happy to live with the profitability dilution from Motorola.

To judge from Microsoft's experience in these things, merely dabbling with hardware will not be enough. Captivated by Apple's first success with the iPod in integrating hardware, software and services into a single device, Microsoft tried the same with its Zune player – but only after wasting time on other approaches first. Like its stab at building a smartphone after the acquisition of Danger, it merely proved that halfhearted and belated efforts to compete with an industry leader with the momentum of Apple are doomed to failure.

Google is now doing its best to put a brave face on its own move into hardware, even though it is the byproduct of an acquisition that was primarily mounted to give it control of Motorola's large portfolio of patents. That does not sound like a promising place to start as it tries to match Apple – particularly given its previous lack of experience in hardware and a culture whose roots can be traced to its engineering prowess rather than its expertise in delighting consumers.

Facebook, whose development has echoed that of Google in so many other ways, will have to set its course in mobile quickly. It does not have a cushion like the search advertising business to fall back on and it is reaching maturity at the moment consumers are switching en masse to smartphones. If the initial drop in Facebook's share price in the days after its IPO was caused by disappointment at the lack of a widely anticipated first-day spike, the continuing slide since then suggests that investors have taken its business challenges to heart.

For Facebook, mobile presents two challenges: those of distribution and business model. It could be well on the way to solving the former. Buying Instagram, though expensive, may have given it ownership of the company that was best placed to turn itself into the "Facebook of mobile" – though it is too early to say whether Instagram can live up to this potential or whether other mobile apps will step into its shoes to become Facebook's next big headache.

Another distribution risk for Facebook is that the companies that control the main smartphone platforms – led by Apple and Google – will stand between the company and its users. Yet the smartphone providers also need to offer a good Facebook experience if they are to lure buyers, and business partnerships seem likely to follow. Apple's Mr Cook hinted as much this week when, asked if Facebook's service would ever be integrated more deeply into the iPhone and iPad, he said: "Watch this space".

Solving Facebook's mobile distribution problem, however, will be different from finding a profitable mobile business model. The extent of that challenge suggests that its downbeat debut as a public company could be set to continue for some time.

More News From Financial Times