Let Me Be Frank: Apple vs Google And Why iAd Matters

I have been thinking about Apple and Google’s competing mobile strategies in the context of this blog post by Joel Spolsky, in which Joel writes about the economics of complementary goods. As I understand it, a complementary relationship between two products A and B are such that if the price of product A goes down, the demand for product B goes up . An example that Joel cites is that at vacation destinations like Orlando, FL, air fare is a complement to hotel rates. As the airplane ticket prices to Orlando decrease, the demand for hotel rooms increases and with it increases the price of hotel rooms. Joel writes, “Smart companies try to commoditize their product’s complements.”

If you think of Apple and Google’s mobile strategies in the context of complements, here is what I think you find. Apple is a hardware company, so they want to increase the demand for iPhones, iPods, and (now) iPads, and to increase that demand Apple wants to lower the price of complements to these products, the applications. We have seen this model throughout the history of computers, but what makes things different this time is that Apple controls the application market for the iPhone, iPod, and iPads. Most of the complaints with Apple are with the applications it does not allow in the App Market, but the bigger issue if you are a hardware competitor with Apple is what they allow in regards to application prices. Ideally Apple would like the price of apps to be very cheap, which increases the demand for their hardware. So far I have not seen anything suggesting that Apple is in fact forcing lower app prices, but Apple’s new mobile advertising service, iAd, announced with iPhone OS 4 will encourage more free and low-priced apps.

Google’s strategy appears to be more complex. Google makes money through advertising that comes through search, and the complement to those searches is both hardware and software, so Google would like to see the prices of both go down. In other words, Google needs the total cost of ownership for computing to go down so that more people can use their search engine to find things to which they attach advertising that makes them money. Google has been making most of its money from searches generated from desktop computing, and searches coming in from mobile computing is a huge market opportunity for Google. Applying the economic theory of complements to Google’s case means they need the total cost of ownership for mobile computing to go down in order to seize the mobile search opportunity.

Google is implementing a multi-pronged strategy to decrease the total cost of ownership for mobile computing. First they release the Android operating system, which is open source and free to smartphone handset manufacturers to use, and because it is free it attracts more companies to use it and sell handsets. In turn, Google is hoping that like Microsoft did with MS-DOS, providing a cheap operating system will drive competition in the smartphone hardware market enough to lower the prices of smartphones, thus lowering the total cost of ownership even more. Google has even recognized the nuances that mobile carriers have added to the total cost of ownership and is trying to address that by trying to establish a store for directly selling phones running Android in what may be an attempt at lowering the carrier’s prices. It also doesn’t hurt that a higher percentage of the applications in the Android Market are free. The entire strategy is designed to get more smartphones using Google’s search engine to generate more advertising and thus make more money.

You might be asking, why did Google have to go so far as developing an operating system, after all, the default search on the iPhone has been Google, so the number of searches coming from mobile phones would increase as more people own iPhones. The problem that iPhone presents to Google is that Apple could always change the search engine on the iPhone to something else, either to Microsoft’s Bing, or perhaps through an acquisition, their own search engine. Imagine if Apple had acquired Yahoo. If Apple can cut Google off the iPhone, and smartphones are the next big market opportunity for Google, they had to get more directly into the smartphone market to insure that their search engine was the default for as many smartphones as possible.

So the battle lines are being drawn between Apple and Google. Google’s strategy to lower the total cost of ownership of smartphones is a risk to Apple because that could force the price for iPhones to go down. The last thing Apple wants is to become the IBM of the smartphone industry and have the iPhones driven to commodity prices. The profit margins on personal computers got so low that IBM sold it’s personal computer division to Lenova and got out of the business. To combat Google, Apple is getting into the advertising business with iAd in iPhone OS 4.0. Apple believes that search from smartphones is not going to be as significant as search has been from desktop computers. Consequently, they see advertising within mobile applications as the market opportunity for mobile advertising and iAd will be the conduit for making that happen both by providing the tools for developers to put the ads in their apps and by selling advertising. Apple hopes that iAd will serve two purposes. First, it hopes that iAd will lower the prices of apps by providing other ways for developers to make money from their work, and as I wrote above, since apps are the complement to the iPhone, iPhone Touch, and the iPad, lower app prices will keep the demand for hardware up and make Apple more money. Second, iAd directly goes after Google’s source of revenue, advertising, and the growth area for advertising, the smartphone market. Obviously, Apple decided it can’t seriously go after the search side of the business because as long as their devices have a web browser users will always be able to use Google, but it is betting that not many people are really going to do as much searching from their phones.