Why the Smartphone Market Works and Why Apple Wants to Kill It

June 12, 2017
By: Rob Enderle

As successful as the iPod market was for Apple it really didn’t work that well for the rest of us because advancement only came when Apple saw a threat.  It didn’t do colors until after HP, it didn’t junk the hard drive until it saw a Dell prototype, and it didn’t do video until Microsoft (News - Alert) launched the Zune (Steve Jobs was really good at calling anything he didn’t do yet, stupid).  Yes, Apple owned the market but every advancement seemed to come as a result of the ever-dwindling competition.   

The smartphone market has been vastly different largely because, like the PC market before it, it has always been vendor rich.  Yes, Apple has a big part but you generally always have a choice of several strong alternatives that are moving more rapidly.  Granted, Samsung (News - Alert) moved a tad too rapidly, and its last phone was so hot it literally caught on fire. 

What both mostly drives this market, and provides us with a rich number of choices, is an intellectual property licensing system that allows a few core vendors to provide a rich choice of product, both keeping prices down and advancement up. 

It is an unusual model but one I didn’t know that much about until I started doing research into how this all works.  Thinking about the song “You don’t know what you’ve got till it’s gone,” and in the face of some strong efforts by large companies to institute changes that would benefit these large companies, I figured it would be good to walk through the basics. 

Computer

In the beginning, there was a big bang; oh wait, too far back, let’s jump ahead to mainframes and IBM (News - Alert).  They brought to market a traditional model where the IP related to a solution was only owned by the supplying vendor, the hardware wasn’t sold, it was leased, and software was free.  And IBM dominated this market with a handful of far smaller competitors, none of whom were really any threat to the company.   Advancement was slow and, although IBM started out being both incredibly benevolent and customer focused, over time the need to grow revenue resulted in polices that effectively encouraged executives to release buggy products so they could charge customers to fix them.  Customers revolted, IBM almost went under, and it still surprises me the number of big company tech CEOs, other than IBM’s, that want to return to that ugly past. 

PCs started a very different trend, that of licensing, and it is interesting to note that while Apple appeared to emulate IBM by keeping things close, IBM aggressively licensed out its technology, making the PC market possible.  It was in that era that the beginning of the cell phone wave was initiated and companies like Motorola (News - Alert) came to the conclusion that licensing technology, rather than just holding it close, could more quickly grow an industry than having every firm reinvent the wheel.  

During this period, the concept of FRAND licensing emerged, (FRAND stands for Fair, Reasonable, and Non-Discriminatory), which, in theory, would prevent someone with competitive problems from raising prices on competitors to cripple them if they were successful.  (Interestingly, the only firm in recent memory that ever did this was Apple, who, after HP licensed the iPod, used pricing to knock the company out of the MP3 market). 

This licensing method provides core technology fairly charged to firms for a total cost of somewhere between 3 percent and 5 percent for the core patents that assure a cellular phone will interoperate on a typical cellular network.  

Portfolio Licensing vs. Individual Licensing and Product Level Pricing

Generally experienced companies prefer portfolio licensing largely because it most effectively avoids litigation costs.  If you license by each individual component, you may infringe on patents and copyrights you didn’t license as soon as you try to solve similar problems with the device the licensee already solved.  For instance, if I were to just license a GE Jet engine, there is a pretty good chance I’d violate its IP when I tried to actually attach it to a control system I didn’t license.  But, if I licensed the entire portfolio, I’d be covered. 

If you go to individual pricing, not only is litigation more likely, but so is the complexity of the deal.  Each individual IP component must then be priced and licensed, requiring a separate negotiation initially and at renewal.  Large companies can certainly deal with this extra cost and complexity both because they are far more expensive to take to court and they have, potentially, far more manpower.   Smaller firms, not so much. But then figuring out how to price the result becomes an issue.  If you set the price flat, people that sell low cost or low volume phones pay huge premiums massively favoring large high price, high volume vendors and forcing the little guys out of business.  So, the industry came around to product level pricing which ties the licensing fees to the price of the device.

All of this together provides a relatively level playing field where small device makers can more easily compete with large manufactures and assures that, in the future, we will always have choices.  Which is why, I expect, the big guys like Apple want to kill this model. 

Wrapping Up 

It would seem the arguments for change largely revolve around a desire to return to the old world where one or two vendors dominated. This would mean a move away from the one we have today, where there are plenty of really good choices.  I just put in my order for the Essential Phone, a unique product technology showcase from Andy Rubin, the guy who created Android (News - Alert), that likely wouldn’t be able to exist (and Apple has been trying to kill) if we didn’t have an affordable way for his small company to license the necessary technology. The big players don’t want phones like this that compete with their offerings in market, and that is why I think they are aggressively trying to change the current licensing model.  That doesn’t appear to be in our best interest.  What do you think?   




Edited by Alicia Young