Has Google Clearly Won Against Apple?

The smartphone war has been raging for many years now, with Google (GOOGL 1.23%) and Apple (AAPL 0.60%) continuing to gobble up unit market share at the expense of every other mobile operating system platform. In a recent BusinessWeek interview, Google Chairman Eric Schmidt said Google is "pretty clearly" winning the war.

Clearly
There are now over 1.3 million Android devices being activated every day. Looking at Gartner's third quarter figures, Android now dominates the global smartphone scene with an incredible 72.4% market share, while Apple iOS is the distant second with a 13.9% slice. IDC's figures showed Android and iOS at 75% and 14.9%, respectively, only slightly different.

In that sense, Android has won in terms of operating system units. Google only benefits on that rise to the extent that those users are exposed to Google's ads or use the company's wide range of online services.

Schmidt compares the rivalry to Apple and Microsoft (MSFT 1.55%) two decades ago, where the software giant's open strategy of licensing to armies of OEMs allowed it to rise to ubiquity. The market share figures are certainly panning out along the same trajectory.

Here's the thing though: unit share is just half the battle.

What about profit share?
When you look at the hardware OEMs actually selling Android devices, it's a pretty bleak picture. Apple grabbed 71% of operating profit share last year, with Samsung coming in a distant second at 16%. That's like flipping those unit shares around, with Apple gobbling up the vast majority of the industry's profits.

Source: Citi via Apple 2.0.

There's no question that Samsung has executed well with Android for the past two years, but remember that once upon a time HTC was the belle of the Android ball and is now struggling for a turnaround after posting its lowest profit in six years. The Taiwanese company's bottom line plunged 79% last quarter. The life of a commoditized OEM is a hard one, and fortunes can change at the drop of a hat.

Citi even calls Apple and Samsung the "only investable smartphone brands."

The even bigger picture
If the smartphone market is to play out like the PC market did 20 years ago, with Android supplanting Windows for dominance, then there's a much bigger picture to acknowledge.

Due to Microsoft's open strategy, the PC value chain inherently became segmented. Microsoft provided the operating system; Intel (INTC -0.16%) provided the processors; PC makers like Hewlett-Packard (HPQ 0.23%) or Dell (DELL.DL) were hardware OEMs. Each layer of the value chain had its own margins, with the commoditized players getting the short end of that stick.

Over the decades, the end result was a unbalanced product where Intel was able to provide the most powerful chips known to man thanks to its unique role, while the quality of overall hardware designs continued to deteriorate as PC makers raced to the bottom on price in the futile attempt to expand their own margins.

It's obvious which companies came out on top in this group. There's a reason they called it WinTel instead of WinPackard or WinDell, and it's not just because it had a nice ring to it.

Source: Reuters. TTM = trailing 12 months.

Those low margins are precisely why HP and Dell are both sick of the PC market. Both companies continue to diversify as best they can away from the PC market and would rather become more-profitable enterprise software and IT giants instead.

This segmentation of the value chain is now beginning to reverse course and reintegrate after Apple showed them how profitable an integrated strategy could be. After 40 years, Microsoft is now dead set on becoming a "devices-and-services" company and integrating hardware and software. It's also expanding into retail distribution and service with its Microsoft Stores, roles previously played by third parties.

Deja vu
This same storyline could be playing out in smartphones, except at an accelerated rate. The Android value chain is even more segmented than PCs. Google provides the operating system; chip designs are licensed from ARM Holdings (ARMH) to companies like Qualcomm (QCOM 0.89%) or NVIDIA (NVDA 3.88%) that tap contract manufacturers like Taiwan Semiconductor (TSM 2.64%); OEMs like Samsung, HTC, or LG fight commoditization with software modifications, but ultimately are still commoditized.

If you know where to look, there's already evidence of a trend toward integration in smartphones. Texas Instruments (TXN 1.50%) is getting out of mobile chips because the larger players continue to integrate further and make "their own custom chips." LG is in the process of making its own chips that will start in TVs but inevitably make their way into smartphones. We've already mentioned Microsoft Surface, which will probably be followed by a Surface Phone and/or a Surface Book.

Google closed its acquisition of Motorola earlier this year, and is keeping the mobile device business (and patents) while selling off the set-top box division. It collaborates with many OEMs in its Nexus program, but it still seems inevitable that a highly integrated Android device made by Motorola will make its way to market one day.

Meanwhile, Apple will continue with its highly integrated strategy and keep claiming its disproportionate profit share. If there's one thing investors like, it's black ink.