Looking at the pure smartphone vendors RIM and Apple, the picture is nothing short of astonishing. This before-and-after share-of-available-profit chart shows that the two entrants went from about 7% profit share to 65% in three years.

Apple in particular is capturing about half of the available profits with three percent of the units. It dwarfs all the other vendors, more than double the nearest (Nokia). All that in three years and with the added burdens of only three models, a recession and limited distribution.

WHAT DOES IT ALL MEAN?

Here are my conclusions, enumerated:

1. The lack of a real response. The recurring theme in this series of articles has been that giant multinational incumbents in a vast and rapidly growing industry, enjoying all the advantages that size and incumbency, have had their profits taken from them. And they don’t seem to have put up much of a fight.

2. It’s all wealth transfer. Note the total amount of profit available has not increased markedly; this is not about incumbents growing the pie. Two thirds of what should have rightly been theirs moved from the incumbent shareholders to the entrant shareholders.

3. Speed. This shift of profit occurred over an unprecedentedly short period of time. Three years is no more than two product cycles in the industry and it’s an order of magnitude faster than what happened historically to other industries.

4. Disruption is the diagnosis here. The incumbents were caught in the headlights. Disruptive innovation leads to asymmetric competition and this is what we just witnessed. History has shown that the shift of profits is usually the last stage of disruption and is usually irreversible because ;the change in business models cannot happen at the rate of change of profit transfer.

There is a secret to Apple’s profit capture. What allows them to get the outrageous margin is that they dip (indirectly) into the service revenues of the carriers. What I really need to do is expose how Apple is using a hardware product to receive service revenues from mobile broadband carriage fees. To get away with this scheme, you need a product that compels people to move to higher ARPU and do so enthusiastically. There are a few pivotal moments in history when customers move to higher price points (think cable vs. broadcast TV and broadband vs. dial-up). Apple is able to essentially carve a piece of the service pie out.

So the question on where the essential value is gives a clue to how the whole “device” EBIT pie will grow. Imagine a transfer of wealth from operators to (a) device vendor. Then you start to see the bigger picture.

Originally Posted by Texrat

I sure wouldn't say all profits, but definitely significant amounts. However, it's not sustainable.

Originally Posted by Hintry

With expanded worldwide distribution (Verizon, etc), Apple's marketshare will most likely grow from its current 3% base and therefore also its profitshare i.e. for many competitors, it's gonna get worse before it gets better.

Originally Posted by Hintry

With expanded worldwide distribution (Verizon, etc), Apple's marketshare will most likely grow from its current 3% base and therefore also its profitshare i.e. for many competitors, it's gonna get worse before it gets better.

Originally Posted by Texrat

Doubt it. We'll see what Android says.

Originally Posted by Texrat

Doubt it. We'll see what Android says.

If Android is to become the dominant platform, does it depend on the success of its licensees? Who are these licensees and what are the chances that they will be able to align their businesses to what Android offers (a new revenue model based on services and advertising).

One problem I see is that Google is making a bet on those same vendors who are now squeezed in the middle of that last pie chart: Samsung, LG, Motorola and Sony Ericsson. Nokia, Apple and RIM will certainly not take the OS over what they already have as it dilutes their differentiation and margins. That means Android is aligned with the biggest losers in the industry.

So how likely are these disrupted ex-giants to recover and take Android forward? My bet: slim to none. Android does not offer more than a lifeline. It is not a foundation for long-term profitability as it presumes the profits accrue to the network and possibly to Google. Profit evaporation out of devices to Google may be a possibility at some time in the future, but only if the devices don’t need too much attention to remain competitive. But because they’re still not good enough (and they won’t be for years to come), it’s certain that attention to detail is what will be most important to stay abreast of Apple

So here we have the real challenge to Android: partnership with defeated incumbents whose ability to build profitable and differentiated products is hamstrung by the licensing model and whose incentives to move up the steep trajectory of necessary improvements are limited.

In other words, Android’s licensees won’t have the profits or the motivation to spend on R&D so as to make exceptionally competitive products at a time when being competitive is what matters most.

Larry Ellison’s Oracle is a tough as nails, down to business firm. It just recently made progress in a long running lawsuit against competitor SAP when that company cried uncle and declared liability in a software theft suit, although it claims Oracle is vastly overstating its damages. That’s not the kind of company I’d want to be suing me.

With Sun’s own mobile Java VM already having largely failed as a viable mobile platform, Oracle has good reason to want to take a bite out of Google’s ascending Android. As the new owner of Sun’s Java, Oracle is looking for ways to make use of its $7 billion acquisition. What better way than to pull out your Sun patents and kick the number one US smartphone platform in the balls with them? It doesn’t matter that Google isn’t making any money in distributing Android, because Google’s business model is to give away software to provide it with more surface area for its ads.

That means Android conveys a lot of value to Google, so Oracle has big pockets to go after for damages from Google’s decision to open source Java without its permission. How this will play out is anyone’s guess, but it’s not great news for the fledgling mobile platform. After all, if Oracle injects new license fees and restrictions into Android’s core kernel, there’ll be little room left for Google to continue subsidizing its support and distributing the software just to expand its ad opportunities. It’s not like Google makes any money on Android itself.