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Why Most Hardware Players Can't Pull Off Cloud Services

The hardware biz ain't what it used to be.

Many gadget OEMs have been trying their darnedest to expand beyond mostly commoditized hardware and boosting margins with various types of services. Even PC maker Hewlett-Packard (NYSE: HPQ  ) had futuristic dreams of spinning off its PC business and focusing on enterprise software to pump up margins, although that initiative failed spectacularly to even get off the ground.

Will the real cloud syncing service please stand up?
On the mobile front, Taiwanese device maker HTC's service launched back in 2010. It was a set of services that let users sync contacts and call history, perform cloud backups of data, and locate their phones remotely, among other things. The service was notably provided free or charge.

More recently, Acer unveiled a new service in January called AcerCloud, which bears an eerie resemblance to Apple's (Nasdaq: AAPL  ) iCloud. Even the slide-show presentation was a total knockoff.

Source: The Verge. AcerCloud (top) compared with iCloud (bottom).

The service does everything you would expect from an iCloud clone: syncing photos, documents, and music between devices. AcerCloud is also on the house, provided that you buy a shiny new Acer PC. It's expected to launch next month in China and North America.

Who's picking up the tab?
Hardware OEMs aren't able to sustain these types of services. HTC has just announced that it's shutting down and that users have until the end of next month to gather their digital personal effects before they're vaporized into the ether of cyberspace.

The company says the site is "undergoing a renovation" to improve the services it delivers, except "your data will no longer be accessible and will be deleted." That means that as HTC is winding down its service, Acer has high hopes of starting a similar one of its own.

iOS users have inadvertently benefitted from, since the free phone-location service played a competitive role in prompting Apple to open up its Find My iPhone app to everyone for free, which was previously reserved for paying MobileMe subscribers. Apple subsequently revamped MobileMe into iCloud and is now free for all iOS users.

Unfit to fly
Therein lays the Catch-22.

Commoditized hardware OEMs suffer from low margins, and while they are trying to boost hardware sales by branching out and offering free services, they're held back by ... low margins.

Last year, HTC saw gross, operating, and net margins of 28%, 15%, and 13%, respectively. Keep in mind that HTC doesn't trade domestically, so you can't invest in it even if you wanted to. For the first nine months of its fiscal 2011, Acer's respective digits came in at 8%, (2%), and (2%). HTC and Acer are Asian players, but it doesn't get much better stateside. Motorola Mobility (NYSE: MMI  ) just finished reported full-year results, with respective margins of 25%, (1%), and (2%).

Compare those with Apple's trailing-12-month gross, operating, and net margins of 42%, 34%, and 26%. Apple's focus on hardware and software integration allows it to avoid hardware commoditization, enjoying juicier margins on the overall package.

It's not over, yet
Interestingly, HTC may not be done with service offerings altogether. The company is rumored to be looking into a streaming music service, and it acquired a significant stake in Beats Audio last year. There aren't a lot of solid details, but this service is suspected to carry a subscription fee so HTC can monetize it.

On top of that, HTC just bought a 20% stake in SyncTV, a TV content-streaming service that delivers programming to connected TVs and mobile devices, among other gadgets. It also invested $40 million into cloud gaming service OnLive a little more than a year ago.

The point is that hardware players are increasingly interested in diversifying away from low-margin hardware businesses and moving toward content and service. IBM (NYSE: IBM  ) took note of this long ago, which is why it sold its PC business to China's Lenovo seven years ago, a move that helped boost gross margin by upwards of 6% since then. No wonder HP wanted to be like Big Blue so badly.

T-minus ...
Integration and additional services alone aren't necessarily the panacea. After all, Research In Motion (Nasdaq: RIMM  ) integrates hardware and software along with services like BlackBerry Messenger in addition to enterprise-security add-ons. Look how it's doing.

Added services from hardware-only players don't have a good track record. I'll be counting down the days until AcerCloud meets a similar fate.

Cloud syncing services are just one aspect of the mobile revolution. If you're looking for another way to play The Next Trillion-Dollar Revolution, then we've got just the special free report for you. This company is powering the revolution from the inside. Get the free report now.

Fool contributor Evan Niu owns shares of Apple, but he holds no other position in any company mentioned. Check out his holdings and a short bio. The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of and creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 29, 2012, at 12:31 PM, melegross wrote:

    In offering a cloud service, a company needs to have a reason other than to think it will make money, directly or indirectly. What can HTC reasonably offer its customers that would make it interesting enough to them so that they would buy an HTC product rather than another?

    I don't see anything. With RIM, we see the same problem. Where at one point in time, having a smartphone was enough reason, it was only because the main advantage of one was the e-mail and messaging. But that's no longer true. It's why RIM is failing.

    Acer will no doubt suffer the same fate in cloud services, as they have little to offer.

    IBM is in a different situation, as they have very robust business software, consulting and hardware that this works in conjunction with. They know their customers very well, and offer then a very broad range of services.

    In the consumer vein, Apple is the equivalent. A broad range of products in the hardware and software realms that work together closely. A customer can move into that ecosystem and have most everything they need. With Apple's high margins, like IBM, due to this entwining of hardware, software and services, Apple can afford to do what they need to without worrying about it damaging their bottom line. Indeed, like IBM, it draws ever more new customers into the fold.

    Microsoft can do this on a software only basic, as their business offerings are also very robust, and their position with OEM's is such that they don't need to have their own hardware to sell, though the XBox is finding a new use in the content use area.

    Other than these three, and to a lessor extent, Google and Amazon, who else can compete here?

    Maybe Apothecker had the right area at HP, but want given the time to implement it. His poor public relations ability hurt him there.

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