Thursday, January 30, 2014

Real Options and the strategic brilliance of Larry Page


(Disclaimer: Although I have worked for Google in the past, I had no access to inside information about the Google-Motorola deal and the strategies. My writing is based purely on publicly available information and my own thoughts on this situation)

Tech pundits are scratching their heads again. Most reactions about Google selling off Motorola to Lenovo range between a massive failure for Google (Mashable) to the typical Schadenfreude (John Gruber). Two blogs that got it right (right = my theory) are Dealbook and Gigaom.

To understand the Google-Motorola deal in the first place, it is important to keep in mind the context of the 2011 smartphone market. On one hand, there was Apple, very willing to go to court with their patent arsenal to crush Android's advances. On the other, there was Samsung - a close ally that was getting powerful within the Android ecosystem and taking away most of the profits. Samsung was already the key supplier to Apple for all their hardware needs, and the Android partnership provided them with a great hedge and huge profits to boot. Competition within the Android ecosystem - despite Google partnering with HTC, LG, Asus etc just did not play out as well, and these companies were unable to counter the marketing might and vertical integration capabilities of Samsung.

People in corporate finance are familiar with the concept of Real Options, and I believe this is what the Google-Motorola deal looked like. (Wikipedia : A real option itself, is the right — but not the obligation — to undertake certain business initiatives, such as deferring, abandoning, expanding, staging, or contracting a capital investment project). I believe that real options are also great strategic decision tools in uncertain market conditions; and in this case they were the perfect instrument.

Motorola was a real option for a considerable cost, which was a great way to get a trove of patents to keep away Apple and others. It was also a great tool to check Samsung's progress with the implicit signaling of superior hardware capability within the company that owned Android, Samsung's profit source.

The steep price tag of $12B for the deal was significant, but it was needed for the greater prize of the smartphone marketshare. In fact, as the Dealbook math shows, it was not a huge price for this play. The value of the patents might be debatable, but it definitely slowed down the patent trolling and shored up the defenses pretty well for Android. In the last two years, it has been pretty well demonstrated that the mobile business is going the PC way - commoditization, and the value really is in owning the platform and the end-users.

Looking at Apple's most recent quarter and market trends, it is quite clear that as smartphones become the only type of phones pretty soon, Android will own at least 2/3rds of the market in the stable equilibrium, while Apple will have the rest. That will be a great outcome for Google - it will have replicated its desktop dominance on mobile too. This war is almost won - which leaves Motorola, the hardware factory, as the option that will not be used. Google is an advertising and a web services company, and it is well aware of that core competence. As for Motorola+Lenovo - it will make for a great competitor to Samsung and the couple other Chinese firms that are beginning to create the perfect set of companies to keep the Android flag flying.