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Alphabet Takes a Page From Apple's Playbook

By Jamal Carnette, CFA – Feb 4, 2016 at 6:12AM

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A new report from The Information finds Alphabet is becoming serious about devices.

Unlike the current Nexus 5X (left) and Nexus 6P, Alphabet may control the entire production process. Image source: Google.

Although Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) is better known for its operating system, the company does have a line of devices: the Nexus line of smartphones and tablets. While both sets of high-end devices tend to receive solid reviews, the company hasn't received the same enthusiasm from consumers. In the end, customers tend to choose Apple's (NASDAQ: AAPL) iPhones or iPads or Samsung's (NASDAQOTH: SSNLF) line of Galaxy devices for high-end Android units rather than Google's devices.

As such, the company hasn't been able to monetize devices to the degree of its iOS competitor, but not for a lack of trying. In 2012, the company purchased Motorola's smartphone business in an attempt to control the entire user experience, much like Apple. After paying $9.5 billion ex-cash for Motorola Mobility, the company sold the parts for a total of $5.5 billion, the last of which -- $3 billion to Lenovo – occurred in 2014 after quarters of divisional operating losses. While Alphabet was able to keep valuable patents, the company never accomplished its goal to be a major player in devices. In 2013, Alphabet's only full-year of reported Motorola Mobility results the company reported a 6% drop in unit shipments on a year-on-year basis. 

While the company's efforts have been uninspiring so far, Alphabet now seems to be taking a different approach -- one that takes a page right out of Apple's playbook.

A stronger relationship with handset makers could further improve the product
A new report from The Information (subscription required) claims Alphabet is going to take more control of the smartphone manufacturing process with the next Nexus release. Currently the relationship is considered a partnership, with Huawei making the larger, high-end Nexus 6P and LG making the mid-level Nexus 5X. The Information reports that Alphabet is looking to change the relationship from less of a partnership to one of control over the hardware process without the huge expense of running an in-house device manufacturing business.

If so, this is moving toward a vertically integrated relationship, much like Apple has with its hardware partners. Essentially, Apple is responsible for the design with Chinese manufacturers performing the assembly. Since Apple's able to control the entire process, the user experience can be further refined and new features such as 3D Touch can be introduced. As such, Apple tends to be a leader in next-gen features in part because of the level of control the company exerts over the entire production process. In a slowing smartphone market, a premium will be placed on companies able to bring new features to improve the user experience. Alphabet moving toward Apple's production process is a wise move for the company. 

While Google is borrowing Apple's model, Samsung could be affected the most
At this point, however, the worst-hit company may not be Apple but rather the largest smartphone maker sporting Android's operating system: Samsung. The flow of consumers tends to be from Android to iOS versus the other way; Apple CEO Tim Cook bragged about the record number of Android Switchers in its first-quarter conference call. It's possible a highly integrated Nexus model will slow that trend somewhat, but Apple's satisfaction rate is 99% for its newest iPhone models according to 451 Research. It will be hard for Alphabet to totally reverse the direction of defectors while Apple has near-unanimous satisfaction.

Instead, it's more likely Alphabet will grow its market share among die-hard Android users by consolidating high-end demand. This would be the worst-case scenario for Samsung, LG, Motorola, and Sony, which make high-end Android units. In the long run this could potentially affect the relationship between handset makers and an ecosystem producer looking to consolidate market share, but Alphabet appears willing to risk it to become more like Apple.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Jamal Carnette owns shares of Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple. 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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