Why Google is Expanding Into Hardware and Why Now

Google recently announced a major move into several hardware products: Google Pixel (smartphones), Daydream View (virtual reality), Google Home (digital home) and Google Assistant (AI-based personal assistant).


This is a sharp contrast for a company that profits primarily from managing the middleware or platform layer (e.g., matching web users and advertisers, providing the operating system for smartphones, and matching buyers and sellers of digital content) and relies on numerous third-party hardware firms (e.g., Samsung) and application developers (e.g., Evernote) to complete its ecosystem. By branching into hardware and beyond its core business of information and search, Google puts itself in direct competition with its ecosystem partners.

Shortly after this announcement, a couple of former students from my “Technology Competition and Strategy” MBA course at UC Davis wrote to me asking “why?” and “why now?”.

The answer lies, to a large extent, in platform economics and network effects, as well as competitive timing.

While the competitive reasons vary across the product categories mentioned above, they are also interconnected. So, let’s examine the most mature of these product categories, the smartphone. Google’s smartphone entry, Pixel, joins a crowded world of smartphones.

Smartphone Competition — Phase I

Multi-sided platforms, such as those for smartphones that connect device users and application developers, thrive on network effects. Specifically, cross-platform network effects. Users find the Google’s Android platform more attractive when it has numerous applications and content. Developers find it attractive to provide applications and content when the platform has a large user base.

How does a new smartphone platform owner compete and entice participation by both users and developers? When Google’s Android was ready for roll-out in early 2009, Apple’s iPhone already was established as an innovative and cool product, miles ahead of competitors, with a large user base and hundreds of thousands of smartphone apps in its App Store (including Google’s Maps, YouTube etc.). The iPhone and iOS was the clear choice for anyone adopting smartphones. Facing Apple’s huge head start, how could Google persuade consumers to adopt Android phones? And how would it persuade developers to make apps for this new system standard?

At this stage, Google had two choices. It could, like Apple, adopt a “closed” approach, and make both the platform software (the phone OS) and hardware (the phone). Or, it could use an “open” approach, stay away from the hardware business and encourage third-party phone makers to make Android phones. Google shrewdly chose the “open” approach. Even though it did produce demonstration phones, or designated a Google phone each year, it made sure not to put other phone makers at a disadvantage.

This open approach fed straight into the hopes of scores of phone makers who were extremely threatened by Apple’s iPhone (indeed several mobile phone leaders such as Palm, Nokia and Blackberry have bitten the dust since then). In 2009, non-Apple phone makers were looking for a savior, and were thrilled to have a smartphone platform that could compete with iOS. Dozens of them began producing Android phones, and this intense competition at the hardware level gave consumers numerous choices across the spectrum from inexpensive to high-performance devices. Consumer adoption of Android phones, coupled with Google’s efforts towards application developers, soon led to a solid library of apps in Google’s Play Store.

So, in Phase I of the smartphone battle, Google performed admirably as an entrant against a wildly popular and profitable incumbent. Android was here to stay.

Smartphone Competition — Phase II

In the next few years, Google continued to improve Android, pushing out numerous upgrades and several named new versions (“Nougat” or version 7.0 was released in October 2016). By 2010, Android was beating Apple’s iOS on installed base, and matched it app-to-app. (Meanwhile, Apple and Google duked it out in the applications space, fighting about whether popular Google apps such as Maps and YouTube would be available on iOS.)

But, Google’s “open” strategy, with hundreds of hardware makers who can customize Android on their devices, has made the Android ecosystem extremely fragmented and unreliable relative to Apple’s iOS and iPhone. New versions of Android become available to consumers only after long delays, based on a complex dance between Google and phone makers. Apps and accessories may not work well across the board. While Apple can unilaterally march ahead with new technological innovations in its phones, Google and Android must make these choices under stronger constraints and while balancing preferences of multiple firms. Disregarding brand loyalty and certain other factors, Apple’s best iPhone has typically beaten the best Android phone over the years.

Smartphone Competition — Phase III

In the next phase, the competitive environment is ripe for Google to make a bold move into phone hardware. Whereas this move would have undermined Google’s efforts to spread Android in 2008, it no longer has to worry about that today. If Google’s entry causes some phone makers to exit the market (because of their competitive disadvantage vis-a-vis the platform owner also making phones), so be it. The brutal truth is that Google used them when it needed, and is no longer desperate for phone partners. Ditto on the application front: Google’s entry into hardware poses no threat that its app library would become weaker than Apple’s. By producing a high-end phone built on a platform that Google knows inside-out, Google can compete head-to-head with iPhone. Time for Pixel.

But there is a bigger reason for Google’s hardware move at this time. Market definitions are changing rapidly, and multiple — until now separate — markets have started overlapping. This is a common phenomenon in technology (see my recent paper with David Evans and Deepa Mani, “The Move to Smart Mobile and Its Implications for Antitrust Analysis of Online Markets”, or this more accessible excerpt). It has important implications for how you compete.

Changing Market Definitions and Overlapping Markets

Specifically, markets such as smartphones, personal computing, digital home, and digital entertainment are converging and overlapping. For example, the smartphone is an important player not just in voice and data but also in the digital home and in personal assistance. The field of opponents is ever-shifting. For example, Apple has been Google’s chief rival in smartphone, but with the new market definitions, Amazon (with Alexa and Echo and Fire) emerges as a direct threat.

Google’s success across these emerging and overlapping markets depends on giving the customer a seamless experience across these markets. The severe fragmentation in the Android world will make it difficult to provide this experience if the customer has gadgets from multiple manufacturers for different functions. By observing customer behavior and usage across these different product categories, Google’s offerings can better respond to the customer’s needs and keep the customer in its own ecosystem. Technologically, this cross-market capability allows Google to leverage its expertise in “artificial intelligence” which it has honed over the years.

For Google, these market shifts strongly influence its core revenue stream of digital advertising, which is deeply dependent on knowing the customer. For instance, while Google was (and is) dominant in web search advertising, it is threatened by other giants. Facebook can be thoughts of as a search and advertising company with a giant social network underlying it, and Amazon serves as a search and advertising company with a giant retail store behind it. It is no longer suitable to view search advertising as a standalone market where Google is a supreme winner.

By offering hardware products in multiple categories, Google makes it more likely that an Android mobile phone user chooses to remain in the Google ecosystem (vs. Amazon) at home. Market share in these other categories will give Google more chances to deploy advertising and also enhance the quality of ads (and price per ad) through better matching and targeting. At this time, Google is not only deeply concerned about Android market share (vs. competitors in each market such as Apple iOS, Amazon’s Echo, Facebook’s Oculus, etc.), but it also wants to own the Android gadget so it can fully observe the user.

Finally, unlike the smartphone market which is now quite mature, these other digital products are still in the early phase, with plenty of market share to be captured and the big players and technologies still undefined. Amazon, Apple, Facebook, Samsung, and others have started staking ground, apart from Google. Because the markets overlap, and because consumers often prefer to live within one ecosystem, Google can improve its chances of building market share in these other markets if it can get more consumers to use not just the Android operating system but also a Google phone.

Take-Aways

Google’s strategic expansion into phone hardware is explained by a mix of platform competition, cross-network effects, changes in market definition, and, of course, timing. The hardware moves into the other product categories come about because of the overlap and cross-market convergence between these categories and smartphones, and the necessity for Google to maintain interaction with its customers across all markets.

This strategy is not without risks. Google could lose its reputation as a supremo in specific markets and products, and instead become an also-ran in multiple markets it knows little about. Google has previously experienced such losses with Google Wave and Google Plus. Google must watch out for this possibility, a fate that has previously befallen other companies, most famously Yahoo!