Virulent Word of Mouse

December 14, 2009

The evolution of value in smart phones, or “Why does my iPhone drop so many calls?”


Randall Stross writes the Digital Domain in the Sunday New York Times. In a recent column he discusses the quality of iPhones and AT&T’s network. His point is obvious from the title of the column: “AT&T Takes the Blame, Even for the iPhone’s Faults.”

Much to Stross’ credit, he investigated common misconceptions about the quality of AT&T’s network. He concludes that AT&T’s network has done reasonably well with the  growth of traffic generated by the iPhone.

More to the point, Stross concludes that popular perceptions about AT&T’s network miss the mark, as do Verizon’s commercials.

I recommend this piece even though I thought it was incomplete.

Let me say that more sympathetically. Stross gets only 800 words, which allows for only one major point. It is no surprise that Stross does not say many things.

Specifically, he does not say that the iPhone’s success foreshadows a large transformation in the flow of value within the market for mobile handsets. He does not say that this transformation coincides with an irreversible change from old rules and new rules in the structure of the value chain supporting the cellular phone market.

But if he had had more space he could have said it.

So let me be blunt. I think I understand the rules of the old game and the rules of the new. I think I understand what game Apple is playing. If I had to bet, I also would bet against AT&T.

These are the points of this post.

Any surprise?

Nothing in Stross’ column should surprise an Internet policy junkie. He points out what most wireless Internet junkies already know: the iPhone is a data hog. More charitably stated, the iPhone has applications that use much of the available spectrum in AT&T’s network, particularly in locations with many users, such as Los Angeles, San Francisco, New York, Chicago, Boston, and just about every major city in the US.

Most Internet junkies will say “Told you so.” You see, though the iPhone just happens to be the first popular mobile device to catch on in the US, something like it has been expected for some time — a very long time, indeed. (This future even gets a small mention in Bill Gates memo, “The Internet Tidal Wave”, which he penned in May 1995. Bit I digress).

Many years ago Internet futurists forecast the proliferation of devices, and most insiders have forecast that the US government released too little spectrum to support that future. This future has arrived, and — whatdoyouknow? — the skeptics were right. We hit the limits of spectrum capacity awfully fast in many major cities.

Stross never says any of that. He does not have to.  Instead, he focuses on the one point, namely, who takes responsibility for the quality of the network and the iPhone.

He begins his column this way: “I LOVE my iPhone. I just wish it were matched with Verizon Wireless, the carrier with the most envied reputation as fast, ubiquitous, reliable, nigh perfect.”

Stross goes on to say, “My sense of Verizon’s superiority is confirmed every time I see a “there’s a map for that” Verizon commercial, graphically showing how far more extensive Verizon’s 3G network coverage is in less populated areas.”

Stross then does something wonderful. He discusses a report from Consumer Reports, as well as several other consultants. Surprise, surprise, he finds that Apple’s iPhone bears as much responsibility for poor performance as AT&T’s network. Apple has a flawed design. AT&T has too few towers.

Stross includes this remarkable observation from Rob Entner, a research VP at Neilson: “AT&T does not publicly defend itself because it will not criticize Apple under any circumstances.” In other words, both parties are responsible, but only one party takes the public blame.

Did I read that correctly? What is going on?

Taking issue with details

First, a minor issue to clear up before getting to the major question.

Let me take a mild issue with Stross’ characterization of quality. I think Verizon’s commercials border on deceptive advertising.

Look, carriers have to figure out how to locate their towers efficiently. In fact, they do not place their towers in every location for an obvious reason: it costs too much to do that.  The US population concentrates in comparatively small set of places, so a firm can serve most of them by only covering urban areas.

In fact, two thirds of the US population lives in fifty areas, three quarters in one hundred, and most urban populations stay inside their urban centers. Sure, some people travel for a living, but facts are facts: most people do not travel far from home. When they do travel far, they tend to travel from one city to another.

Think of it this way. Most Midwestern and eastern US geography consists of cows, corn, and cotton. Most western US geography consists of mountains, water, and desert. Cities do not occupy most of the land area. With the notable exception of Los Angeles’ sprawl, most cities appear as dots against the larger landscape.

More to the point, to support 90 percent of cell phone use companies locate their towers in only a small set of locations. That would appear as dots on most maps. For similar reasons AT&T can support most of its customers, and, accordingly, AT&T’s map looks dotted.

Verizon made an expensive choice. They chose to put towers in places where few people live, and along highways where few people drive. That is why their map looks filled in. It is great for those who live in low density locations, but those towers along rural highways do not get used very much. It is an expensive marketing ploy for all the city dwellers.

More bluntly, Verizon’s big geographic coverage just does not matter to most urban users. If you live in a big city, why would you care whether a phone works where the Buffalo roam? Who cares whether it works at a ski resort?

Look, do not misinterpret me. I am sure some big city users care, a few perhaps. But I am also sure that most do not. Even when they travel, most big city people travel between the dots by plane.

In short, the Verizon coverage might appeal to non-urban customers, as well as people who drive trucks for a living, or roam the countryside in a Winnebago, but, frankly, that is not most people.

My own experience informs my views. I have had an iPhone for over a year, and I too loved my iPhone, just like Stross.

That was at first, however.  I am learning to despise the network. The iPhone drops calls all over Chicago. Despite using the same network as my wife’s Blackberry, we perceive that her phone works more reliably.

I want my iPhone to work during mundane tasks. For example, I want it to work inside the grocery store when I call home about whether to get Downy with or without scent. (It is very frustrating to make that call three times just to find out that the answer is “Without scent, and get some Soft Soap refill, and not in the small size.” But I digress.)

More to the point, I could care less about national coverage, or those Verizon commercials. I just want the phone to work at the office, on the freeways in Chicago (where I live), and at the hotels in a few other major cities I tend to visit frequently, such as Boston, Washington D.C., and San Francisco. I am a city person and I travel between dots most of the time.

(BTW, the Verizon commercials also are deceptive on a more technical point. In principle, the phones can work anywhere, with or without 3G, while the maps show only 3G coverage, which is more relevant to the phone’s data downloading capability. But I digress again).

Back to my qualification of Stross’ key premise: I agree with Stross that Apple has shown that phones can become cool toys. That was fine at first, but no toy is worth the trouble if it cannot complete a call. However, I do not agree that Verizon’s response highlights the point. The commercial exploits the complaints with AT&T’s network, but, upon closer inspection Verizon’s commercials display a picture that has little relationship with network quality.

Which still leaves the questions about the game being played between AT&T and Apple. Let’s get there.

Who to blame?

So why is AT&T purposely taking the blame for all the dropped calls instead of Apple? After all, there are two firms here. Both parties should bear some responsibility.

I can guess. In brief, AT&T is living according to the old rules in one respect and not another.

What are the old rules? To make a long story short, for the last twenty five years US network carriers have had total control over every aspect of the value chain in cell phones.

As was well known inside the industry, the US carriers pushed around all the other business partners, making all the partners live with exacting requirements. None of the partners liked it, but the carriers had a standing excuse for this behavior, namely, quality. That is, the carriers pushed everyone around in order to realize promises about quality.

BTW, most of the business partners had a different view. They viewed this process as a tug of war. They thought the requirements reflected a belief by the carriers that value flowed to the party who controlled something unique. That is, pushing around business partners led to a greater fraction of value flowing to the carriers, who could get away with this behavior because they controlled a rare resource, spectrum.

Look, I am not going to settle differences between old screeds. The old rules had their goods and bads (e.g., excessively high quality, limited choices, slow roll-outs of new designs, weird contracting rules for users), but let’s overlook that for now. I am just saying the old era worked the way it worked.

Anyway, back to the point: There is something respectable about AT&T’s behavior, and also something rather clueless.  Taking responsibility is respectable because it leads to more investment in cell towers. However, giving up competitive advantage is clueless. According to old rules, AT&T should be pushing Apple around, but that does not seem to be happening.

What is going on? My guess at the answer: Perhaps the old rules do not apply to the value chain for the new phones, and, perhaps AT&T has little bargaining power with its business partner.

What are the new rules and how do they differ from the old? Ah, that will take a moment to explain.

It’s a consumer product

Begin with this comparison: What is so special about cell phones in comparison to other consumer products?

The answer: not much.

Phones are hardly phones anymore. They include games, maps, directories, news sources, and a bit of email. Phones have more processing power than the first several generations of PCs, and developers have been enjoying the iPhone platform. More apps are on the way. Moreover, the presence of the Internet supplements the phone’s capabilities, so the phone is really a mobile Internet gateway, just with a smaller screen.

(Like I said at the start, this has been forecast for some time. But I digress again.)

What other product involves advanced engineering, and, yet most consumers can manage their way through it? Hmmm, that describes flat screen TVs, PCs, laser printers, Stereos, VCRs, Wiis, gameboys, X-Boxes, or Camcorders.

Value does not remains elusive to buyers in consumer electronics just because the underlying mother boards are complicated. In short, the phone is not far away from becoming just like another piece of consumer electronics.

Consumer Reports has developed standardized metrics, and so have plenty of other user-oriented forums. Transparency emerged as users figured it out. Moreover, firms developed brands to signal to users which devices have competent organizations behind them. Distributors like Best Buy developed geek squads to sell them.

To be sure, the norms of consumer electronics has its goods and bads (e.g., rapid incompatible change, confusing menu of choices, low margins for sellers, deceptive advertising, occasional orphaning of service obligations), but let’s overlook that for now. I am just saying that this is how things work.

Here is the upshot: When the value becomes associated with the device, then the network becomes one dimension of the product. The network contributes little additional value.

Let me say that one other way, using familiar language from consumer electronics: A device with a strong brand has little reason to acknowledge the value of only one component.

Where does this evolution lead?

From watching the PC industry for years I recognize the game Apple is playing with AT&T. Apple learned this game from Microsoft, to whom it lost in the PC market. The game is called “Migrating value from one business partner to another.”

To be sure, Apple is making a bet.

Apple’s bet crucially depends on this industry evolving as the futurists have forecast. It also depends on Apple being out front with whatever is hot, and it depends on Apple generating loyal repurchases.

What game does AT&T think it is playing with Apple? Right now they are in an exclusive relationship with Apple. They seem to be betting that relationship will last if they treat their partner nicely. Either that, or they are betting that devices will become common and the network will emerge as rare, at which point they can push around others, just as they used to.

AT&T’s bet is not totally crazy. Apple is not the only firm making progress.  Google, Palm, Microsoft, Motorola, Nokia, HTC and others are too. Perhaps devices will become common enough to give the carriers bargaining power with device makers.

Still, in the bet between AT&T and Apple I know where I would place my bet. How about you?

9 Comments »

  1. Shane,

    I have had heated discussions with my MIT colleagues regarding Google’s possible entry in the handset market. Will you take that up anytime soon? It’s a bit of a moving target, since we do not know yet if this is a calculated feint or a more radical departure. And my own reactions range from “they’re crazy competing with their customers” to “handset manufacturers are clueless about software, they need a firm (non-apple) hand to show them the way.” I would love to know where you stand…

    Pierre

    Comment by Pierre Azoulay — December 16, 2009 @ 4:25 pm | Reply

    • Great question. Part of what Google appears to be doing makes strategic sense (the open source part) and part of it does not (competing with their business partners), at least on the surface. The latter still puzzles me, and I suspect that I do not know all the relevant information. SG

      Comment by Shane Greenstein — December 16, 2009 @ 4:38 pm | Reply

  2. With the very unfair benefit of this being written after Google’s Nexus One announcement, instead of a couple of weeks ago when the original post was written:

    – Nexus One is something of a reference design. Google will continue to work with whatever players are necessary in order to speed the adoption of the Android OS.

    – Google’s pricing model of “less than free,” their strong brand, Apple’s tremendous success with the iPhone, and the general roiling of the industry waters create a situation where it’s not so clear whether the behavior of a partner is detrimental conflict or simply the ongoing evolution of an industry.

    Comment by Lee Wright — January 7, 2010 @ 7:56 pm | Reply

    • That is a fair comment, and a reasonable point. And I agree that the Nexus raises additional questions about the direction of evolution of the industry.

      Professor Shane Greenstein Kellogg School of Management Northwestern University

      Comment by Shane Greenstein — January 7, 2010 @ 8:33 pm | Reply

  3. Professor Greenstein:

    Even though competing with business partners might not make sense on the surface, Android has failed to gain traction; most probably because Motorola is pretty much a dead brand in the smartphone market and also because of a (yet) very small ecosystem. By the way. I still can’t understand why they launched Android partnering with Motorola.

    Having a Google phone, certainly enhances the cool factor (the Google brand), which should accelerate the adoption of Android and thus the growth of the ecosystem.

    So in my opinion, even though this might seem conflictive in the short term, it should be beneficial in the long term.

    As a loyal Iphone user, I would consider trying an Android phone, but only because now it’s a Google phone (the only thing as cool as an Apple phone). I would have never tried Android on a Motorola or Samsung phone.

    Best regards,

    Patricio

    Comment by Patricio Mois — January 8, 2010 @ 2:13 am | Reply

  4. Patricio,

    Your statement “never (tried) Android on a Motorola or Samsung phone” puzzles me. NexusOne h/w is from HTC. No different from Droid h/w is from Motorola (No implication that HTC is comparable to Motorola). Could’nt it be that Google figured out that coming out with HTC-Google phone is a few steps behind HTC-G1 (with TMO) and is not super-phone, they decided to take HTC out of the branding (paid money!) and just brand it as Google “SuperPhone”?

    Best,
    Dileep

    Comment by Dileep Varma — January 8, 2010 @ 1:24 pm | Reply

  5. Here are my thoughts as to why Google entered the Phone Hardware market:

    – They realized that the game is an Apps game – it’s all about the ecosystem of which the OS plays only one part. With 18K Apps vs. Apple’s 100K, the only way they can catch up to the competition is to take control of the Apps development pipeline. Now with several Android versions (1.5, 1.6, 2.0, 2.1) out there and half a dozen OEM customizations of the UI (MotoBlur, Bada UI, Sense UI, Rachael UI, etc.), the current Apps development model is a nightmare for any developer (compared to developing on one OS/one phone for the iPhone). Hence, by proposing a lead device, they are offering the developers a lead platform for development. The OEMs will have to match the lead device.

    – They realized that the Ad business, using AdWords and AdSense, would not work on a phone screen the way it does on a large screen web-site (sorry Hal..). The AdMob model (showing one ad at a time) is significantly different from the auction-based AdWords model with much less revenue generation power. The phone HW model allows them to make money on the HW as well instead of just ads. Google must be realizing that bankrolling all of its “free” products R&D with only search money is a limiting business model.

    – They are not very smart as one would think:
    — maybe they are clueless Apple wannabes
    — maybe they are confused (read their open source manifesto on their blog – they are ambivalent about whether they are an open source company or a closed source company)
    — maybe they do not understand the mobile space
    — Some of the flaws with the online shop model and the consumer complaints seem to indicate that they did not quite understand the mobile business
    — Their hints at a “dream device” that will work on all networks (see Engadget interview of their manager) are technically ignorant

    Google seem to be repeating a version of Microsoft’s story – well-loved in the beginning but later hated by many due to their often-reckless behaviors. In Google’s case it is less arrogance and more “giddy idealism” (to borrow the inimitable David Pogue’s words) that seem to be driving them.

    Comment by RC — January 12, 2010 @ 8:45 pm | Reply

  6. I find it so amazing that the computer giants and Google (the internet giant) play such huge rolls in how the cellular world is shaping and growing. I’m curious to see how the Android phone stacks up against the Iphone in a couple of years. Thanks for the post, It was very informative. Keep it up and I hope to run across some more posts of yours in the near future.

    Comment by Personal Injury Attorney Augusta — January 19, 2010 @ 2:02 pm | Reply

  7. nice blog and very informative writeup keep it up. http://bit.ly/bcrU0P

    Comment by tracy — March 22, 2010 @ 7:06 am | Reply


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