Are Free Motorola Phones in Our Future? A VC’s Take on Why Google is Buying Motorola

8/17/11Follow @vcrebecca

I was invited to go on Bloomberg West TV on Monday when news broke of Google’s plan to acquire Motorola for $12.5 billion in cash. I hadn’t had much time to digest the news before going on live television and found myself verbalizing my gut instinct: that is, I think Google will at some point give Motorola phones away for free in a profoundly disruptive move to own the mobile advertising framework.

I now have had a day to think about what I said—and I still stand by it. As a venture capitalist with investments across a number of mobile startups, my advice to my portfolio companies is simple: plan for a scenario in which Google gives away Motorola phones for free and imagine how the market would be shaped in its wake.

What Google Did and Didn’t Say

Most commentators believe it’s all about the patents. Motorola’s 17,000 patent portfolio and 7,500 pending patents could be used to defend Google’s ecosystem of handset manufacturers who embed the Android operating system against lawsuits, such as the one Apple lobbed against HTC. That’s certainly logical and a plausible position for Google to take. Google’s handset partners have been asking for relief from patent suits for some time. Pundits also point out that Motorola has a set top box business, and Google could use the acquisition to push Google TV. Another good point.

But here’s what I believe. Google’s business is search advertising. Everything they do is an effort to grow search. Why buy a handset manufacturer? Answer: To make more money on search. Google’s mobile search business is estimated to be $1 billion and growing by year end. Since mobile is undergoing the most rapid technology adoption in history, Google needs to own the “last mile” to the eyeballs. What better way to own that last mile than to control both the hardware and software environment, like Apple does with the iPhone today?

Right now, Google has little or no control. The Android ecosystem is “open” and increasingly fragmented with Android available on some very good phones as well as some cheap ones with varying quality. Google would like to control both the quality and “the deck” of services that’s embedded on the phone. They want to see all Google services baked into the phone right out of the box—from search, to maps, to their new and rapidly growing Google Wallet that allows you to use your smartphone like a credit card.

Data Fuels Advertising

Owning the consumer interface means having control over future monetization opportunities. Search, maps, and Google Wallet alone would give the company a … Next Page »

Rebecca Lynn is a partner in Morgenthaler Ventures’ Menlo Park office, focusing on early-stage investments in mobile, health IT, Internet, and financial services. Follow @vcrebecca

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  • Chris

    How would the Android partners feel about a “free” competitor? Google would win the race to the bottom. I am doubtful this would every happen.

  • Cash

    Huh. Interesting. I see you’re a venture capitalist. I have a way to get the BOM for Android smartphones down to the $10 needed for your plan. Send me a check for $1mil and I’ll cut you in on the deal.

    Please ensure it is made out to my name.
    They call me Cash. Kinda like Sting, or Seal.

  • Walt French

    So how is it that Apple (a) contracts out all its manufacturing and yet (b) shocks the world with first- and best-in-class products, while maintaining huge margins? Contrasted to Motorola, when given pretty much a blank slate, opportunity to collaborate closely with the Android team, came out with the Xoom?

    I think something other than ownership of the chain is the issue.

    Google has already announced a much tighter control on Android devices, their integration of Google software, etc. (Although outsiders could be forgiven for not having yet seen the results). These moves addressed lousy quality. Memos such as the SkyHook exhibits show that Google is quite capable of directing what it really wants: volume, high volume and faster higher volume.

    Organizational theory recognizes both plusses and minuses from vertical integration. In Google’s case, they have succeeded wildly from the separate model. In Apple’s case, … uhh, they, TOO have succeeded wildly in contracting out assembly (and, we have to presume, some of the finer points of design for display technology, etc.).

    By all accounts, the MMI acquisition is a turn-on-a-dime move, something to do with IP, or in my conspiracy theorizing, with protecting Android’s reputation of inevitability from *potential* pending judgements and collapse of MMI. Google mumbled the requisite “keep the factories humming” noises designed to keep morale from disintegrating. But zero vision as to how Google would actually use the company beyond its patent portfolio. It’s an afterthought.

    Meanwhile, where is the evidence that Google has lost a single sale from not having as polished an experience as Apples, where that lousy experience was due to inattention by the many OEM partners? Has something about design goals or technology changed in the last 5 weeks?

  • Frank

    Giving away hardware is completely different than giving away software. Software costs are mostly in development, with some operational costs re servers, advertising, etc. Actually making a phone efficiently enough to make the BOM reasonable, then handling the operations of contracting production facilities, shipping, etc- that is a whole different ball of wax. Good luck with that googlezola. Apple isn’t just Apple because of Steve Jobs- Tim Cook and the rest of the team are also the engines and brains that allow Apple to make the best products for the least money for the most profit.

  • Ann

    I completely agree with you on Google, but you made a mistake investing in Practice Fusion or any EHR for that matter. Where did those numbers come from that you site in the article? How many Physicians are using Practice Fusion? It’s not about how many patients are using an EHR right? It’s about doctors, nurses and staff using it and clicking on those ads right after they enter their chart notes. Can you imagine documenting your discussion with a patient; let’s say you had to tell your patient his cancer is terminal, what ad do you think will pop up after you type that in?

    Free is good, but not for everything.

    EHR adoption is less than 40% among doctors, call your own doctor or pediatrician tomorrow and ask. And while you’re at it show them Practice Fusion.

  • http://mexepos.tumblr.com Marcos El Malo

    “Google would like to control both the quality and “the deck” of services that’s embedded on the phone. They want to see all Google services baked into the phone right out of the box—from search, to maps, to their new and rapidly growing Google Wallet [. . .]”

    This is a good point, and maybe part of the decision to buy MMI. MMI could be a gun to point at the Android partners that might want to lock in non Google services (Bing?).

    However, your proposed solution sounds ridiculous and quite VC-ish. I don’t even know where to start, but suffice it to say, giving away hardware is a bit different than giving away software. Do VCs typically have anything to do with companies that aren’t operating at a loss, but that will start generating net profits right after the IPO?

    Unless you mean giving away a limited number of phones in some sort of promotion. Give phones to radio DJs and their staffs, then give them 10 a day to give away for a week? That might work. Maybe the DJs could interview the local Frink who could tell them the difference between free as in open and free as in beer.

    Bottom line is that Google isn’t a start up. They’re a profitable company and are supposed to stay that way. One hopes that buying MMI was a well thought out strategy. Giving away phones sounds like a tactic without a strategy.

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  • Brian Ward

    Ms. Lynn, I think you may be failing to recognize that the currently collapsing desktop environment means the end of Google as it is today if its search revenue is limited to the desktop environment and/or restricted in the mobile environment. Android devices were doomed to either be banned due to patent infringement or have license fees that would price them out of the market, potentially reducing Google search revenue to a small fraction of what it is today. Google is smart. They saw the future, and it was Apple’s (and maybe Mircosoft’s) advertising platform on mobile devices, not Google’s. Especially given that Apple is pushing for a restructuring of the Internet away from being web-centric to being app-centric. Apps (and ads) that Apple controls. At least with Motorola’s patents, they have a fighting chance. And who’s to say that they couldn’t spin/sell Motorola right back off again as its own company and recoup some of the 12.5 Bil. In less than a year, phones and tablets will have quad-core processors powerful enough for the significant majority of consumers to be able to use their phones as their primary computer, docked similarly to the current Atrix and upcoming Bionic, and what Apple’s AirPlay promises. This is evident from Dell’s revenue guidance and HP’s effective abandonment of their PC business. Phones for free? I guess its possible with a subsidy from the carriers, and it could give them a leg up since there is no profit pressure like Motorola had. But while possible, I strongly believe the purchase of Motorola is Google somewhat desperately grasping at a lifeline as it sinks under the weight of patent claims.

  • Charel

    How much of the one billion Google earns on mobile search is generated from Apple’s iOS? If it where all from Android you may have a point, but I doubt it.

  • http://ARMdevices.net Charbax

    I agree that if Google does keep Motorola’s hardware business (and doesn’t repackage and resells it after keeping the patents), then for sure Google will want Motorola to sell cheaper and cheaper phones. I’m talking sub-$50 before the end of this year is totally possible. I bought a $87 Android phone in China http://armdevices.net/2011/04/11/best-of-shenzhen-87-android-3-5-capacitive-phone-mtk6516-fg8/ there are new cheaper ARM Processors that can make sub-$50 Android phones before the end of this year a reality. And those sub-$50 Android phones aren’t crappy at all, they can have 3.5″ capacitive touch screens, instant web browsing and apps speed and the latest Android software. The sub-$50 Android phone is important because that is a 5-billion phone market potentially for as soon as the next 2-3 years already. So it means huge sales, something like totally replacing all Nokia symbian sales overnight and also replacing all feature phone sales instantly.

    As for those sub-$50 phones being given away for free. Yeah for sure why not. With pre-paid data-only free Google Voice plans in US and Europe, that is totally doable without losing any money on hardware.

  • Peter

    @Walt French: “I think something other than ownership of the chain is the issue.”

    You are forgetting that Apple “owns” the chain that manufactures their products. Maybe not direct (legal) ownership but Apple makes significant (billion dollar) investments in their partners, tells them exactly what they need to do, how to do it and at which price. And Apple contractually ties up their partner’s production capacity for years.

    While Apple may not manufacture the parts themselves, they still totally control what happens at the manufacturing facility. That’s not the same as “contracting out”. It’s more like owning a massive production facility consisting of best-in-breed companies that will march wherever Jobs tells them too.

    Apple is an extensively vertically integrated company. It’s the control of every aspect that makes their products stand out. If Google wants to truly compete with Apple in the iPhone arena then they are smart to steal some of Jobs’ moves. In that case Google also needs to control both the hard- and the software.

    Giving away free handsets? Sure, it’s all about the financial model, isn’t it. With $50 phones available, what’s not possible?

  • http://www.affenstunde.com James Barnes

    Owning the mobile terminal does *not* mean you own, or in any way control, the ‘last mile.’

    The ‘last mile’ belongs to the mobile network and/or WiFi/WLAN.

  • fandroid

    android phones are already free with contract. This is how they’re able to move that crap in the first place.

    Maybe google will start paying people to take them?

    Or did you mean free without contract?

    Sure, I’ll take 100,000 please.

  • Andrew

    This article is staggeringly short sighted. Let’s give Google a huge benefit of the doubt and say they make $10/year per Android user via Ad Revenue. Unlikely, but stay with me here.

    Let’s also say that Motorola can make a compelling phone for $50 (after advertising, costs, shipping, etc.), again it’s incredibly unlikely but let’s go with it.

    People get a new phone every two or three years. So they’ll give away $50 to make $30.

    This isn’t like a company like Sony or Microsoft taking a hit on their game console in a hope to make it up on game purchases/additional services. This is a company paying $50 to obtain a customer who at most they’ll make $30 from.

    I know as a VC you don’t actually care if a company is profitable, all you care is if you can get out for 10 times what you put in. Therefore, while the world knows that LinkedIn isn’t worth more than a few hundred million (if that), VCs push it and get their friends at Forbes to laud it’s praises, and somehow it gets valued at 8+ billion. As someone already mentioned, Google is not a startup, and at some point they’re going to need to make back all the money they’ve spent on Android (after this sale goes through let’s say 14 billion in total for the sake of argument), giving away 20 million phones at my way marked down rate of $50 will cost Google it’s entire Mobile revenue stream. Why would they even dream of doing something so silly?

  • http://george.com George

    This is the worst article on the acquisition I’ve ever read.

  • http://ObamaPacman.com/ ObamaPacman

    Motorola purchase price is $12.5 billion. That is TWO YEARS of Google profits. With all the legal uncertainties, the cost of moto might go up even higher.

    Free = money losing for years. It might even violate some laws in terms of market flooding.

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  • JP K

    I’m always amazed that so many of these Google/MMI acquisition articles completely leave out the developing world.

    A lot of the comments on here talk about Apple using apps to try to push Google’s web based approach out. If you’re view of the world is limited to rich, first world countries like the U.S., then this is almost, kind of plausible (but wrong IMO).

    The developing world is where its at. You know, that vast majority of the population of the world which don’t yet own a smartphone. There is a phone being sold for $90, without contract, in Kenya. It is a smartphone running Android and is selling extremely well. What is Apple going to sell in Kenya? Or Microsoft for that matter? The point I’m making is this: Those phones in Kenya will give Google revenue. In fact, Google can get revenue selling devices that are obsolete by Western standards to people all over the developing world.

  • Andrew

    @JP K,

    If Google’s main source of revenue is Ad driven, how does selling phones at zero profits (or a loss) to Kenya help them at all? No way a customer of Google is going to pay the same per Ad click if the click is coming from Africa.

    Unless you are saying they are jumping full fledged into the hardware business? So let’s say they make $10 a phone in profit off selling to the 3rd world, they’d have to sell 100 million Motorola Phones to make 1 billion in profits. 100 million. A year. Just to the third world.

    That’s no way to run a business.

  • Byron Hathaway

    Think globally.

    If Google purchases the iridium satellite network from the private investors who bought it at fire sale prices of about $25MM US,using the Motorola technology, they would then “cover” the planet and be able to make google tv work everywhere as well as who knows what else in the world of telecom/information delivery.

    Then, the purchase price of $25B would seem to be one of the great buys of the past ten years, if not the past 50 years.

  • sean

    This is very do-able. CPG companies routinely focus on lifetime value and are willing to acquire at a loss and wait over a year for cumulative profits. Look at her background. She’s ex-P&G and a marketer. She’s probably run the numbers to rationalize the position.

    This seems to be a directional thought. For example, they could only partially subsidize phones or not give them to all-comers (e.g., broke people) while employing the same logic. She’s succinctly making a good, if broad, point.

    Besides, I think I read on AllThingsD that they could have bought a similar IP portfolio for $3-$4B. So, what other ideas rationalize the significant premium to Google. Larry Page is not dumb. There’s got to be a reason.

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  • Chris Noble

    It’s the carriers who own the Last Mile, not the handset HW/SW suppliers. And Android phones are already given away by the carriers, bundled with 2-yr contracts.

    The Google/Motorola deal is obviously a complex and interesting development. Xconomy, please avoid the temptation to publish shoot-from-the-hip, unresearched reactions. Not good for your brand.

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  • http://www.landofsheep.com Andrew Best

    You mean free phones without a plan? A lot of phones are disguised as free right now so this won’t mean much in north america. People pay for the phones with the carrier’s long plans that include data and phone usage. I think Google wants a lot of things out of Motorola and most of it is so they can get the competition to step up their game. I’m sure the patents are part of it too. It seems most people are having trouble with the question, “was it for the patents?” I’m sure that was part of the story and I’m guessing there were many reasons they bought the company. We’ll wait and see. I was surprised to hear how many new employees they are getting though. that’s a large % increase even though they will still be quite separate from each other. There is an interesting piece on http://www.landofsheep.com on the Google and Motorola deal that is worth taking a peak at.

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  • Ben Markham

    “pre-paid data-only free Google Voice”
    This I think is the future. Google’s already building out high speed broadband networks in KC, it’s not impossible to think they would build out a high speed mobile network (5G?) some time in the future. Then they could offer data only phones with Google Voice/Google Talk/Huddle/Google+ all integraded into the experience. Google could eventually truly own a complete end to end experience. Manufacture the devices, create the OS and core applications, and run the network!

    Kind of scary and interesting the think about. But Google probably is ambitious enough to pursue it.

    Free phones? I don’t know, with cheaper models I suppose. I can’t imagine the Bill of materials to ever be cheap enough that a Droid Bionic or Galaxy S II or Nexus Prime could ever be given away for free on any large scale.

    The talk of how Google Wallet works in to this is also interesting. I imagine they could integrate Google Offers, location, places, maps, and NFC capabilities into Google Wallet. Imagine, you search Google places for restaurants in your area, and places on your list with a Google Offer available are highlighted. You find a place you want to go and purchase a Google Offer for it through Google Wallet. Then after you eat you tap your smartphone on an NFC capable device to redeem your Offer and then sign and leave a tip.

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  • SoboSimo

    How about moto offers $50 phones at cost but with $50 of credit at google’s app store? ehhhhh? The illusion of free w/o really being free…
    just a thought…

  • GRAHAM HAGUE

    I STARTED USING MOTOROLA BEFORE ANYOTHER PHONE IN THE WORLD AND I FIND THERE PHONES HAVE THE STYLISH LOOKS AND NOT JUST THAT THE BEST APPS AND OTHER GADGETS BUILT IN AND I THINK THERE ON THE  WAY TO A VERY SUSSESFULL PRODUCT THAT ONEDAY EVERYBODY WILL WANT ONE,,IM TELLING YOU FROM SOMEONE THAT HAS HAD ALOT OF DIFFERENT PHONES IN THE DAY AND I THINK FROM NOW ON IL STICK TO MOTOROLA FROM NOW ON THERE GOODLOOKING  AND THE BEST INVESTMENT IVE EVER HAD IN ANY ELECTRICLE DEVICE,,KEEP UP THE GOOD WORK PEOPLE,,AND LOOK BEYOND THE FUTURE.THANKYOU MOTOROLA.

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