Channels for New Markets: Google's Nexus One

Story by Steve Wunker
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With much fanfare, Google launched its Nexus One handset in January 2010. Not only was this powerful cellphone a showcase for what the company’s Android operating system could do, but it also introduced a business model innovation — Google would sell its own handsets directly to consumers while simultaneously licensing Android to other handset makers who would sell handsets through the traditional channel of wireless carriers.

Just because the model was innovative doesn’t mean it was a good idea. With a few months hindsight, did Google have a smart strategy? What does the Nexus One tell us about channels for new markets?
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One explanation for Google’s move is that it wanted to enter the $100 billion market for smartphones as a new source of growth. Certainly the revenue numbers may have looked enticing, but the industry is highly competitive and profit margins are thin (except for Apple’s). Moreover, Google relies on handset makers like Motorola to license Android. The strategy would seem to undermine Android’s long-term prospects with these manufacturers.

Another explanation has been that Google wants to reduce the wireless carrier to a “dumb pipe”, much as Apple has with the iPhone. By owning the whole user experience, Google could own the customer and create huge leverage over its carrier partners. This can be an effective way to pioneer a new market, reducing dependence on channels less motivated than Google to showcase all that the Nexus One can do. The approach could have a high pay-off (look at Apple’s nearly 50% profit margin on iPhone sales of almost $5.5 billion in the last quarter). Yet the strategy would be very risky. Carriers have a major retail presence, own many enterprise customers, and provide critical subsidies for handset purchases. Alienating carriers could backfire on Google. Indeed, the company recently backed down in a dispute with Vodafone, allowing this leading global carrier to sell the phone like a traditional handset, through normal channels. A dispute with Verizon Wireless has led the #1 American carrier to drop the Nexus One from its planned line-up. If the Nexus One were targeted at a niche, perhaps it would make sense to circumvent the huge carrier channel. But the N1 has seemed to have mass market aspirations, so spurning carriers is a perilous move.

A final explanation is somewhat devious, but perhaps the most sensible: Google never intended to be a major player in handsets, or to create a viable direct channel. It used the Nexus One as a ploy to force operators to embrace Android and Google Search on other handsets so that they could compete with the device. Now that phones such as the Droid showcase Google’s mobile capabilities as effectively as the N1, the company can gradually back away from the direct business model. If this was the strategy, it was a brilliant success. Oftentimes a new market pioneer won’t have the visibility to pursue this route effectively, and it may lack Google’s resilience had carriers and other handset makers come to view the company as a major threat. But Google is Google. It had the credibility, customer reach, and deep pockets to make this strategy work.

The moral of the story is that companies should choose direct channels for new markets only if they are pursuing a focused niche of customers (usually, this is a good idea). Companies will run big risks if they rely on third-party channels for part of their business while competing with those same channels in other endeavors. A direct approach might be effective for initially launching an offering for mass markets, but after the initial wave of customer enthusiasm fades channel conflict can be as real in new markets as in any industry. Google seems to have walked this tightrope with great skill.