The ASUS effect : Mobile innovation triggered by open source, long tail devices and a shift in the device value chain

Introduction

Note: The ASUS eepc is a sub-notebook costing about $360 running Linux. The intention of this blog is to discuss the impact of Open source software and the PC value chain on mobile devices.

Having worked and met many developers globally over the last few years, the most common question I hear is: How do we get our application on devices?

It is not an easy task – and I always wanted to do a blog about why that is so. But also on a more optimistic level, why it will also get easier to have new applications on devices.

The traditional chain of thought is: The Operators are too risk averse, network integration takes a long time, the application platforms are fragmented etc etc

These are indeed important factors – and they are being alleviated by the deployment of the Mobile Web (which unifies the Web and the Mobile Web), IMS(which separates the network layer from the service layer), the iPhone (which provides a better revenue model for developers), Cell ID databases(which provide location by bypassing the Operator) and others.

However, there is a more fundamental problem aside from those listed above – and we discuss it here.

Essentially, the existing mobile device value chain is brittle and does not lend itself to change. However, triggered by Open source – that scenario is changing. I am calling it ‘Long Tail’ devices i.e. a possibility that devices may be manufactured and deployed in smaller quantities – thereby encouraging a diversity of new ideas and innovation.

As open source (and specifically Android) takes off, there will be many more new device manufacturer entrants. It will be easier for many new companies to become device manufacturers (with help from companies like ODMs like e28 who are already developing for the Android stack).

This approach is more similar to the PC industry. It is helpful for innovation because many new ideas and technologies cannot be deployed on devices today since the value chain is optimized towards economies of scale – making it risk averse.

Operators and other network providers can now start to take a much more granular approach to devices and then start to experiment with new technologies in devices like SCWS , holographic mobile handsets and so many others

In other words, currently new technologies depend on the Big 5 handset vendors to take off. In future, as ODMs(Original design manufacturers) become very accomplished then it will be possible to produce specialized devices in smaller quantities – with the differentiation being provided by the higher (services) layer of the stack.

Supply chain excellence

In the current ecosystem where the end-user uses mainly voice and SMS, the Operating system and higher levels of the stack do not make a difference. Hence, factors influencing the customer’s purchasing decision include form-factor/design, brand, and price. In this ecosystem, the scale achieved by top 5 handset manufacturers is a huge barrier to entry for newcomers and also new ideas.

Note that this scale is necessary at the phase of evolution of the handset value chain but may not necessarily apply to the future value chain for mobile handsets when fixed costs decrease.

The current situation /leadership is based on supply chain excellence with the market leader Nokia having one of the best supply chains in the world across industries ie. not just mobile phones.

Mastery of the supply chain achieves economies of scale. Economies of scale apply to ecosystems with higher fixed costs. However, as the fixed costs decrease, then we start to get a more divergent market. We will discuss how fixed costs for handset development are likely to decrease.

Profitability – Average selling price and the BOM costs

The market for handsets can be broadly classified into two categories: The mass market devices in emerging economies and the more expensive devices in mature economies.

Emerging markets provide the higher subscriber numbers – but margins are low. Mature markets are based on handset replacement cycles. In all markets, the average selling price continues to drop by about 8% year on year across the top five vendors . In addition, the average bill of materials (BOM) of a mobile handset is expected to decline from US$102 in 2006 to US$86 in 2012. Other factors like single-chip designs have significantly helped in pushing down cost

To make further reductions in the BOM cost, we now need to address software stack costs, IPR costs and development costs (integration/testing etc) which constitute some of the most important elements of the BOM.

That’s the status quo as of 2008.

Now, from here on – as open source (and especially Android and also Symbian) reduces the software stack costs and IPR costs; differentiation shifts to modularization, integration and services (i.e. higher in the stack). Consequently, we have the possibility of new devices which are no longer bound by high fixed costs.

Note that the handset value chain is already modularized. Many of the handsets are being developed by ODMs from Taiwan and China. (The distinction between ODMs and OEMs continues to blur – but for the purposes of our discussion – we can say that ODMs do not have their own brand. They develop their devices based on reference designs from Chipset manufacturers).

Chipset vendors like Freescale, Marvell, NEC Electronics, Qualcomm, and Texas Instruments have all announced reference designs at Barcelona.

There is of course a fixed cost involved at the chipset/reference design level and chipset vendors need at least $2.5bn of sales to cover min. R&D requirements.

However, in the case of Android – that cost may be spread out over a large number of potentially new and existing players who may enter the handset device market – and these players will differentiate not on the device but based on services and application level software.

So we can expect that ODMs will use these designs to create actual devices.

ODM, white labels and innovation

The value created through a lower BOM cost from open source is the trigger to a wider range of devices.

As fixed costs decrease, the mobile phone supply chain will mirror the PC supply chain. The PC supply chain is less brittle and more flexible and does not have as many layers as the mobile value chain. Hence, it is far more adaptable

If the market for mobile phones follows the PC market, then there could be as much as 40% white label devices . In contrast, the big five control as much as 84% of the market today

(For Q2 08, the sales percentages for the top 5 handset makers is as follows: Nokia 41.1%, Samsung 15.4%, Motorola 9.5%, LG 9.3%, and Sony Ericsson 8.2% Rest 16.4% – source Chetan sharma consulting)

In addition to a wider range of devices, there is of course likely to be a range of applications that can benefit from a wider number of devices.

Let a thousand devices bloom

Who benefits from this?

In the end the customers and developers will be the winners as is always the case with open systems and open source. Customers, because they will have more choice and developers because they will have more avenues to deploy their ideas.

The whole ecosystem will also benefit as a result. If the impact similar to that of the ASUS is to be mirrored on to the mobile ecosystem, then we are likely to see a wider range of cheaper mobile devices with the differentiation being provided by software

Comments

  1. Ajit – Good deconstruction of the value chain.
    My question is around your conclusion about the benefits – not necessarily questioning the benefits to consumers and developers in the long run. But in the short/medium term, especially developers are left to choose across at least six (if not more) different device OS environments.
    For the vast majority of developers, this is pretty daunting given the complexity of mobile app development. Yes, there will be some winners but in the short term, it seems like fragmentation will still rule and act as some kind of a ‘governor’ on the true innovation potential of mobile apps/services.
    Vishy

  2. Stefan Constantinescu says:

    Please fix the link to ‘have all announced reference designs at Barcelona.’ there is a period after the html that needs to be chopped off.
    I can’t help but agree with your conclusion that there are too many factors all lined up that should make the top 5 scared since we’re going to have new players coming from places that today we can’t even imagine, with designs that are bleeding edge.
    It’s all about design at the end of the day, people buy the prettiest device in the shop.

  3. Ajit Jaokar says:

    Thanks for your comments Vishy. kind rgds Ajit