How Google Impacts the Premium Smartphone Market

Google has the ability to put a lot of wood behind this arrow.

Jan 11, 2014 at 2:00PM

According to the Wall Street Journal, Google (NASDAQ:GOOGL) recently  cut prices on its flagship MotoX to $399. The question investors should ask is, what affect will this have on the smartphone business?

Wood behind the arrow 
The MotoX is sold only in North and South America and, by volume, sells far fewer units than either Samsung (NASDAQOTH:SSNLF) or Apple (NASDAQ:AAPL). In fact, as of mid-November, MotoX stood at a disappointing 500,000 . This number pales to Apple's 33.8 million iPhone's sold last quarter, so why would the company think cutting the price of a poorly selling smartphone could have a potentially dramatic impact on the world's most enviable smartphone makers, Apple and Samsung?

First, Google's has spent a considerable sum to market the MotoX. Google has the ability to put a lot of wood behind this arrow, and has chosen to do so. Furthermore, while there is no doubt that Google would have loved to sell 30 million MotoX units at premium prices, it suits Google's long-term interests to forego margins and near-term profits in exchange for market share. Why?

Google doesn't necessarily need to make money on its hardware. Google is content to get users into its Android ecosystem, where the company will reap increasingly valuable data that helps support the moat around its search engine as it learns the preferences of individual users.

How important is this data to Google? To paraphrase a Google exec, "We don't necessarily have the best algorithms, we simply have the most data." This statement explains the fruit Google derives from giving away software for free. That's in addition to getting users in the habit of using apps like Gmail and Maps, and eventually Google docs, as its assault on Microsoft Windows and Office continues.

Carriers subsidies ending?
The perception is that, in terms of quality, the iPhone and Samsung Galaxy are the best phones on the market. As carriers have traditionally subsidized phone upgrades every two years, it made sense for consumers to do so only when they became eligible.

Enter T-Mobile, which announced that it would offer no subsidies, instead making the cost of your monthly plan cheaper. Where before, most of the newer phones cost consumers (a subsidized) $200 at most, it was a no-brainer to choose whatever was perceived to be the best phone available, when in fact the "subsidy" is priced into mobile contracts.

Last quarter, only 21% of smartphones sold by T-Mobile were iPhones. In contrast, 51% of Verizon's smartphone activations were Apple devices. While part of the explanation for this is that T-Mobile got the iPhone long after the other carriers, and therefore already has an entrenched Android user base, there is no doubt that price sensitivity exists when consumers must foot the whole bill for a new phone.

With rumblings of ending subsidies at both AT&T and Verizon, this suddenly makes a lower-priced flagship phone like the MotoX much more attractive.

This will undoubtedly negatively impact sales for both Samsung and Apple. Google can, and will, operate at much lower margins in exchange for data and extra sales via their ecosystem.

More negativity
Google will have a more dramatic impact on Samsung sales. Google bought Motorola not only for its patents, but also to obtain more competitive leverage over Samsung, which was believed to be wielding too much power as the dominant profit-maker from Android phones.

Further, there will always be die-hard Apple loyalists who demand the Apple experience. However, Apple refuses to license iOS to other handset manufacturers. One Apple product begets another, as they function seamlessly and in unison. Customer satisfaction scores are off the charts.

The Android experience on a Samsung is largely the same  as other phones, less the poorly functioning bloat-ware Samsung adds to its phones. As the MotoX catches up in specs and added capabilities, there becomes little reason to pay substantially higher prices for a Galaxy.

Bottom line
Google's foray into producing and marketing proprietary hardware, then selling those devices for much lower margins, combined with the possibility of carrier subsidies disappearing could have a significantly greater negative impact for Samsung than for Apple.

Samsung, despite its enormous resources, will probably not be successful in developing its own ecosystem, as the company is simply light years behind both Apple and Google, and even Microsoft. I remain bullish on Google, although its P/E of 30 is a bit rich for a normal company, its search engine is as wide as can be, and it funds its moonshot projects (driver-less cars, robotics, etc.), which may end up revolutionizing the world.

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Margie Nemcick-Cruz owns shares of Apple and Google. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple and Google. 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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