Apple, Google and the Smartphone Revolution

STEVE JOBS UNVEILING APPLE`S IPHONE

On a Tuesday in early January 2007, Steve Jobs announced Apple`s long-awaited leap into the
mobile phone business though the introduction of the iPhone and renaming the company "Apple
Inc." to reflect its increased focus on consumer electronics. During the launch, Jobs highlighted
how the iPhone would "reinvent" wireless communications, "leapfrog[ing]" past the then current
generation of smart phones. The launch accelerated Apple's transformation from a computer
manufacturer to a full-fledged consumer electronics company. With the iPod’s product range,
Apple had become the largest platform for digital music playback (iTunes and iPod franchise), a
platform that now commands approximately 75% of the market for downloaded music and
portable music players. Even before Jobs’ announcement, Apple had sold two billion songs on
iTunes, lifting the company into one of the top ranks of music sellers worldwide. The iPhone
supported the same music features and a smooth integration for existing iTunes users. In addition,
the phone had a built-in two-megapixel digital camera, WiFi and Bluetooth support and a slot for
headphones and a SIM card.

In sync with the iPhone launch, Apple announced several strategic partnerships to increase overall
utility for iPhone users. For example, Google Maps was preinstalled; in his presentation, Jobs
demonstrated this integration with Google Maps by using an iPhone to locate the closest Starbucks.
Eric E. Schmidt, chief executive of Google as well as a member of Apple’s board, joined Jobs on
the stage to endorse the new hand-held. Schmidt emphasized the incredible job Apple did to
develop the iPhone, noting that, through the iPhone, Apple and Google were working closely to
"merge without merging."

The iPhone entered a fast-growing cell phone market, in which, at the lower end, mainstream
handset makers such as Motorola, Nokia or Samsung, and LG had dominated sales, as had
BlackBerry's Research In Motion and Palm at the higher price point. The first iPhone competed
for high-end users with a $499 minimum starting price at its basic configuration. Table 1 shows
the market shares and margins of some of the major competitors prior to the introduction of
Apple`s iPhone.

Professor Rahul Kapoor, The Wharton School and Associate Professor Thomas Klueter (Wharton, PhD Class of 2013), IESE
Business School prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling
of an administrative situation.

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Apple, Google and the Smartphone Revolution

Table 1: Market Share and Profitability of Top 3 Handheld manufactures

Name Market Share Average RoS Gross Margin 2005

H1 2006 2002-2006
Nokia 42.00% 11.03% 35%
RIM (Blackberry) 6.50% 3.07% 55%
Motorola 5.30% 3.97% 32%
Source: Gartner Inc, Compustat, Dedrick, J., Kraemer, K. L., & Linden, G. 2011. The
distribution of value in the mobile phone supply chain. Telecommunications Policy, 35(6): 505-521.

As with all mobile phones, the iPhone needed a wireless network. In 2007, the wireless service
market in the U.S was quite concentrated, similar to most other countries (see Table 2). Wireless
service providers competed in a number of areas: coverage (including factors such as dropped
calls), plan attributes (price, rollover minutes, free calling to other subscribers of the same
provider), customer service quality, and the quality of handsets. Service providers were
aggressively working to attract new customers and to maintain current ones by improving coverage
and service quality, fine-tuning plan attributes to provide innovative services, and offering the
latest handsets to their customers.

Typically, wireless carriers sold mobile devices when clients signed a fixed-term contract (e.g.,
24-month) at a discount and with rebates on new devices. Such agreements helped the wireless
firms lock in customers. In a few cases, handset manufactures offered specific high-end models
exclusively through one carrier (such as Motorola’s Razr V3 for AT&T) but always made available
alternative models offered by other carriers. Verizon was the largest US wireless provider with the
fastest growth and was considered No1 in terms of data and voice reliability.1 However, when Jobs
approached Verizon for the iPhone, he was turned down as the wireless provided was not
comfortable to give up substantial control with respect to design, manufacturing and marketing.
Thus, Jobs opted to have the full range of iPhone products operate exclusively on AT&T Inc.'s
Cingular Wireless network. With AT&T he, also, negotiated a novel revenue-sharing arrangement,
which could give Apple about $10 a month from every iPhone customer's AT&T bill.2 In addition,
customers signing an AT&T contract would receive no discount for iPhones.

Table 2: Market Share and Profitability of Top 3 Wireless Providers in the US

Wireless Network Providers Market Share Average RoS Gross margin

2006 2002-2006 2005
AT&T 35.00% 14.19% 58%
Verizon 34.00% 7.69% 71%
Sprint 18.90% 5.27% 61%
Source: Gartner Inc, Compustat, Dedrick, J., Kraemer, K. L., & Linden, G. 2011. The
distribution of value in the mobile phone supply chain. Telecommunications Policy, 35(6): 505-521.)

1
Verizon, 2006 Annual Report
2
Fred Vogelstein, “The Untold Story: How the iPhone Blew Up the Wireless Industry,” Wired, January 9, 2008,
https://www.wired.com/2008/01/ff-iphone/

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Apple, Google and the Smartphone Revolution

In 2008, after only a year of sales, Apple jumped to third place in the smartphone market. That
same year, the company launched the 2nd generation iPhone (iPhone 3G) and introduced the Apple
App Store. Developers were then able to offer apps to create value for Apple`s iPhone users, while
Apple subsidized those developers by making the apps available to them at cost. When launched,
there were 500 apps offered in the App Store; five years later, the total number of apps surpassed
the milestone of a million apps. Apple's tight control enabled it to deliver an exceptionally smooth
user experience, with hardware and software working together seamlessly.

GOOGLE`S LAUNCH OF ANDROID FOR MOBILE

In October 2007, Google unveiled its plan to develop Android as an operating system for mobile
phones. That system was based on the technology of Android Inc., which Google bought in 2005
for $50mm. The organization offered its operating system to all major mobile providers, who, at
that time, typically relied on their own operating systems (e.g., Linux and Nextel for Motorola or
Nokia`s Symbian, which was preinstalled on almost 1.3 billion phones). Google was
fundamentally rooted in the PC search space as a software company and had very successfully
established its foothold on Windows-operated platforms. However, Google lacked a mobile search
strategy.

When Google introduced Android in 2007, the company said it would concentrate on developing
the operating system software and let traditional phone manufacturers, such as Motorola and HTC,
make the devices. As Andy Rubin, head of Google's Android business put it: "One or two devices
don't matter…Twenty or thirty or a hundred devices, all running the same software—that's what
matters." Over time, initial attempts to introduce its own hardware (such as the Nexus One in 2010)
were discarded. The Android strategy was similar to Microsoft's, supporting a wide range of Intel-
compatible personal computers produced by hardware manufacturers. For many decades, starting
in the early 1980’s, the WINTEL (Windows-Intel) collaboration (initially through MS-DOS and
later, Windows) had been successful. However, in contrast to Windows for PCs, in principle, use
of Android was free and served as an open source, with monetization through apps and
advertisements. Thus, Google did not directly profit from Android but assumed that it would get
more people onto the internet, whereupon the company could benefit from searches and ads.
Google explored additional ways to make money, e.g., by opening an online store to sell music
and videos to Android users.

The software kept getting better, and top handset makers like HTC, Motorola, and Samsung
jumped onboard, rolling out dozens of Android-based devices. In addition to making Android
available for free, Google also let phone makers change the code and customize it so that an
Android phone made by Samsung would have a different user interface from an Android phone
from Motorola. Google believed this open-source model gave Google an advantage over rivals
such as Apple that were selling closed systems, as well as operating their own online stores.

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Apple, Google and the Smartphone Revolution

APPLE VS. GOOGLE – 3 YEARS LATER

In 2010, it became obvious that the rise of Android had resulted in the transformation of the
Google/Apple relationship. A year earlier, Apple had refused to approve two Google apps for sale
to iPhone users, raising questions about how much of a Google presence Apple would allow on its
devices. In August, Eric Schmidt relinquished his seat on the Apple board of directors. Steve Jobs
explained that, "Unfortunately, as Google enters more of Apple's core businesses, Eric's
effectiveness as an Apple board member will be significantly diminished, since he will have to
recuse himself from even larger portions of our meetings."

The key battleground for Apple and Google would be mobile computing, i.e., users tapping into
the internet via mobile devices, thus replacing the use of desktops. Both companies intended to
create the strongest ecosystem of apps and devices. In 2010, Apple had a substantial lead as
developers had created more than 125,000 mobile applications for Apple devices ― seven times
as many as exist on Android ― and the endless diversity of apps has helped the iPhone quickly
pick up 15% of smartphone share, compared with 3.5% for all the Android-powered devices
combined.3 At the same time, however, Android had leapt past Apple to become the biggest
smartphone platform in the United States, the third-biggest worldwide, and by far the fastest
growing.

The ¨battle” between the companies closely resembled Apple´s earlier fights with Microsoft in the
PC era. Back then, Apple leapt out to an early lead with the Macintosh, whose revolutionary
operating system ran only on Apple machines. But Microsoft came up with a version of Windows
that could compete with the Mac. Because Microsoft licensed its software to all of the world's
computer makers, it eventually controlled 90 percent of the market.

Steve Jobs reflected on the tensions between Apple and Google during the fourth quarter earnings
call in 2010: “Last week, Eric Schmidt reiterated that they are activating 200,000 Android devices
per day, and have around 90,000 apps in their app store. For comparison, Apple has activated
around 275,000 iOS devices per day on average for the past 30 days, with a peak of almost 300,000
iOS devices per day on a few of those days. And Apple has 300,000 apps on its App Store. Google
loves to characterize Android as “open,” and iOS and iPhone as “closed.” We find this a bit
disingenuous, and clouding the real difference between our two approaches. The first thing most
of us think about when we hear the word “open” is Windows, which is available on a variety of
devices. Unlike Windows, however, where most PCs have the same user interface and run the
same apps, Android is very fragmented. Many Android OEMs, including the two largest, HTC
and Motorola, install proprietary user interfaces to differentiate themselves from the commodity
Android experience. The user's left to figure it all out. Compare this with iPhone, where every
handset works the same . . . The multiple hardware and software iterations present developers with
a daunting challenge. Many Android apps work only on selected Android handsets, running
selected Android versions. Compare this with iPhone, where there are two versions of the software,
the current and the most recent predecessor, to test against.”

3
See Apple vs. Google: How the battle between Silicon Valley's superstars will shape, Businessweek, 2010, January
14th

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Apple, Google and the Smartphone Revolution

In addition to Google's own app marketplace, Amazon, Verizon, and Vodafone have all announced
that they are creating their own app stores for Android. This is going to create an enormous
problem for both users and developers. Contrast this with Apple's integrated App Store, which
offers users the easiest-to-use, largest app store in the world, preloaded on every iPhone. Apple's
App Store has over three times as many apps as Google's marketplace, and offers developers one-
stop shopping to get their apps to market easily, and get paid swiftly. Keep in mind that, even if
Google is right, and the real issue is “closed” versus “open,” open systems don't always win.

In reality, we think the open versus closed argument is just a smokescreen to try and hide the real
issue, which is, “What's best for the customer ― fragmented versus integrated?” We think Android
is very, very fragmented, and becoming more so by the day. And, as you know, Apple strives to
produce an integrated model so that the user isn't forced to be the systems integrator. We see
tremendous value at having Apple, rather than our users, be the systems integrator. We think this
represents a huge strength of our approach compared to Google's: when selling to users who just
want their devices to work, we believe that integrated will trump fragmented every time. And we
also think that our developers could be more innovative if they can target a singular platform,
rather than a hundred variants. They can put their time into innovative new features, rather than
testing on hundreds of different handsets. So we are very committed to the integrated approach,
no matter how many times Google tries to characterize it as “closed.” And we are confident that it
will triumph over Google's fragmented approach, no matter how often Google tries to portray it as
“open.”

Table 3 shows the development of global smartphone units shipped and the main players in the
industry following the iPhone launch up to 2012.

Table 3: Global smartphone shipments from 2007 to 2012, by vendor (in million units)

Samsung Apple Nokia HTC RIM Others

2007 - 3.3 60.47 3.72 11.77 43.1
2008 5.4 13.8 60.5 7.5 23.6 40.6
2009 5.5 25.1 67.7 8.1 34.5 32.6
2010 22.9 47.5 100.1 21.7 48.8 63.7
2011 94.2 93.1 77.3 43.6 51.1 135.3
2012 219.7 135.9 35.1 32.6 32.5 190.4

Discussion Questions:
1. How was the mobile phone industry organized prior to the launch of the iPhone? How
were firms creating and capturing value?
2. What were some of the key aspects of Apple's entry strategy with the iPhone?
3. Why did Google introduce its own Smartphone operating system (OS) Android?
4. How was Google’s strategy different from Apple’s?
5. Do you agree with Steve Jobs’ analysis of Apple’s iOS and Google’s Android
ecosystems during the Q4, 2010 Earnings Call? Why or why not?

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This document is authorized for use by Sara Bertozzi, from 1/1/2022 to 9/1/2022, in the course:
LGST 212/BEPP 212: 401 Economic Analysis of Law - Buccola (Spring 2022), University of Pennsylvania.
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