Who Captures the Value — Audio and the Smiling Curve

My overriding thesis (and reason for starting this blog) is that consumer audio systems are turning into ‘computers’. If indeed true, it would make sense to apply tech/IT frameworks and tools to analyze how the consumer audio industry might evolve. One such framework is the Smiling Curve, via Wikipedia:

“A smiling curve is an illustration of value-adding potentials of different components of the value chain in an IT-related manufacturing industry.
…in the personal computer industry, both ends of the value chain command higher values added to the product than the middle part of the value chain. If this phenomenon is presented in a graph with a Y-axis for value-added and an X-axis for value chain (stage of production), the resulting curve appears like a “smile”.”

In other words, component makers such as Microsoft and Intel and brand-name computer makers captured more value than the factories that assembled the hardware and white-label computer brands. This played out in the PC industry, although as Ben Thompson notes in a recent article on Stratechery, the curve may not have been completely symmetrical:

“Windows and x86 processors were effectively a bundle, and Microsoft and Intel split the profits. Remember, bundling is how you make money, and in this case Intel-based hardware provided Microsoft a vehicle to profit from licensing Windows, while Windows built an unassailable moat for both — at least in PCs.”

Ben also goes on to note how the bundle took a bit of a different form in the smartphone industry, with Apple bundling the OS and the final hardware product (manufactured under contract), and Google bundling the OS and cloud services with Android.

If we apply the Smiling Curve to the consumer audio industry, it was likely somewhat symmetrical until recently. However, the advent of speech recognition and voice assistants have the potential to completely alter the shape of the curve and the structure of the bundles within it.

With the Echo and Alexa, Amazon was the first to market with a successful voice assistant product, selling millions of units and creating a new category from scratch that quickly outgrew traditional home audio categories in unit sales. Now, Amazon is working to get Alexa on a variety of devices not marketed by Amazon, but by other brands. This is akin to what Microsoft and Google did with their operating systems in the PC and smartphone markets, respectively. It remains to be seen if Google will license out its technology in a similar way, but they most likely will, following the same path they have taken with Google Cast. Microsoft would likely take a similar approach with Cortana. We are waiting to see what Apple will do with Siri, but they are more inclined to control the entire product and market it themselves — as they do with Macs and iPhones.

So where does this leave the established audio brands accustomed to outsized value capture? For all the reasons mentioned above, they aren’t looking like very attractive acquisition targets, even though the industry has seen modest growth in recent years. It seems unlikely any have the time and competence to build a competing voice assistant. Do they build products with another company’s voice assistant(s) and multi room audio ecosystems — more closely resembling white label PC manufacturers?

If the industry does continue to move towards products with voice assistants from Amazon and/or Google, perhaps the best course of action is to invest backwards in the value chain. They could acquire companies producing specialty components, such as audio digital signal processors, audio algorithms, microphones, and speaker drivers. Unfortunately, many components used in these new voice assistant speakers are common to smartphones, and the companies producing them would therefore be too large of a purchase for an audio brand. But the interest in voice assistants has led to the creation of several interesting software, hardware, and algorithm startups that could be good acquisitions targets for audio brands looking to remain relevant.