Google Once Again Takes Aim at Wireless Carriers

Google (Nasdaq: GOOG  ) hates wireless carriers. But then again, who can blame the search giant? Wireless carriers are one of the biggest problems in the mobile sector, although they definitely qualify as necessary evils within the value chain. Those pricey networks aren't going to build themselves.

Carriers have successfully entrenched themselves and locked down their power through a potent combination of subsidies, service contracts, device exclusivity, and technical-standards incompatibilities -- all designed to encourage subscribers to stay put and pony up more every month. In industry speak, that's lowering customer churn while driving up average revenue per user.

To their credit, carriers have successfully, and perhaps permanently, put a ceiling on how consumers value smartphones, since the market has clearly voted in favor of low upfront costs in exchange for higher monthly fees. Almost no one is willing to pay full retail price for a smart device anymore, even if that entails lower usage fees.

Google tried to change that once domestically and failed. With the freshly unveiled Nexus 4, it's trying it again abroad.

A trip down memory lane
When the search giant launched its Nexus One in January 2010, the most notable aspect of the release was the new distribution model that Google tried to implement. An unlocked, unsubsidized model was available for purchase directly through Google's website for $530. At the same time, buyers could opt for the more familiar contracted, subsidized price of $180 on T-Mobile's network, but these were still sold directly by Google.

The device hardly made a dent in the massive market, with early estimates pegging the first week's sales at just 20,000 units. That figure is effectively a rounding error compared to Apple's (Nasdaq: AAPL  ) iPhone, which sold 1.6 million units that week.

The experiment was obviously aimed at reducing the role of wireless carriers by selling directly to consumers and owning most of the relationship. Apple's attempt at unsubsidized sales with the original iPhone in 2007 also fell flat. It was an ambitious undertaking, but it unsurprisingly failed, and the next Nexus S adopted more traditional distribution and sales through carrier partners.

If at first you don't succeed
Google tried it both ways with the Galaxy Nexus. The LTE-equipped model was sold through carriers, along with standard contracts and subsidies, but the search giant also offered an unlocked HSPA+ model directly through its Google Play storefront for $350. With the LTE model's lower price, as well as carrier backing and retail distribution, it's safe to say the subsidized version sold better.

The Nexus 4 that was just announced is yet another attempt by Google to disrupt the traditional subsidy model, despite the fact that it is again available on one carrier that's willing to subsidize it, T-Mobile. Google is aggressively starting at a $300 unsubsidized, unlocked price point, which is within reach of consumers' willingness to pay.

The most glaring omission of the Nexus 4 is that it won't feature LTE connectivity or be available on the three largest domestic networks. Those two facts really tip Google's hand with what it's attempting to do here strategically.

You got some 'splainin' to do
With 3G standards, a GSM/HSPA device can potentially operate on hundreds of networks all over the world. A pentaband device like the Nexus 4 can operate on almost any GSM/HSPA network. This is what Google is looking for: an unlocked device that can be used nearly anywhere and reach a wide audience, launching in seven countries next month.

In contrast, LTE interoperability is a nightmare from a technical standpoint, meaning a single model can't handle all the various LTE networks. For example, Apple had two models of the iPhone 4 (GSM and CDMA), and then one model of the iPhone 4S that could handle all 3G networks. But now it needs three different models due to the complexities of LTE compatibility. Apple prefers simplicity, so you know it wouldn't have done this unless it was absolutely necessary.

Verizon (NYSE: VZ  ) and Sprint Nextel (NYSE: S  ) demand that LTE devices also work with their older CDMA networks -- a standard not widely used outside of the U.S. AT&T's (NYSE: T  ) LTE uses different frequencies and also won't guarantee unlocked devices gallivanting on its LTE network will work properly. Working with the top three domestic carriers simply wasn't going to work.

Android chief Andy Rubin specifically told The Verge: "Tactically, we want to make sure the devices are available for every network on the planet." Sadly, that means no LTE.

Try, try again
Subsidies are widely considered a hindrance to innovation. Don't just take my word for it; here's T-Mobile's CMO Cole Brodman in March, arguing how bad subsidies are for the industry:

Purchasing phones at steep discount (subsidized by wireless carriers) devalues the incredible technology innovations coming to market. It distorts the cost of devices and creates an uneven playing field for OEMs, carriers and retailers alike. Many Americans don't realize the actual cost of the phones they're purchasing with a two-year contract because the cost of that phone is included in the cost of their data plan and the fees associated with their contract. We've also unwittingly created a disposal marketplace for some pretty amazing products.

Source: T-Mobile Blog.

Even though the Nexus 4 is available subsidized on T-Mobile, it's only because that's the status quo. Google is trying to disrupt the current distribution model in favor of what it undoubtedly views as a "more open" system. Can it succeed this time?

You may find it strange that I'm so critical of carriers yet own shares of AT&T and Verizon myself. The only reason I own them, despite recognizing their negative effect on the industry, is that they pay rock-solid dividends, in part because they're so entrenched. Dividend investors should check out this special free report that outlines nine rock-solid dividend stocks, including one of the wireless carriers I own. Claim your 100% free copy by clicking here.

Evan Niu, CFA, owns shares of Apple, AT&T, and Verizon Communications. The Motley Fool owns shares of Apple, Google, and AT&T.; Motley Fool newsletter services recommend Apple, Google, and AT&T. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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