Google's Foray Into Mobile Phones Is Risky

The apparent plan of Google Inc. (GOOG) to produce a mobile phone under its own brand has unsettled the wireless industry, but the Web giant won't find it easy to replicate the same success it's achieved on the Internet.
Last weekend, the company issued Google-branded phones to some employees, fueling reports it will sell its own handset directly to consumers by early next year. Yet Google has been cryptic about its wireless strategy and its motives remain shrouded.

Until now, Google has focused on developing Android, its own mobile software platform for wireless phones, and licensing it for free to handset makers such as Motorola Inc. (MOT), Samsung Electronics Co. (SSNHY, 005930.SE) and HTC Corp. (2498.TW). Just as recently as last month, a senior executive insisted Google had no plans to compete with its handset partners by making its own phone.

Many industry analysts think Google should stick to that pledge. By producing its own phone and selling it directly, Google could alienate handset partners and actually harm its main goal of getting the company's software onto more mobile devices.

What's more, critics say, Google would be entering a lower-margin business in which it has little expertise, as well as fundamentally alter its DNA as one of the most creative software companies in the world. Success in hardware requires huge economies of scale and massive capital investment, but much like the computer industry, profits have steadily been squeezed as the handset business is commoditized. The bigger profits lie in software development, experts say.

"At the end of the day, I think it would be a big mistake," said Frank Dickson, vice president of mobile research at the firm In-Stat.

Search For Mobile Strategy

What's driving Google's foray into the mobile business may be a desire to dominate the market for Internet searches, just like it does on laptops and desktop computers. The company generates the bulk of its $20 billion-plus in annual revenue from ads its places in results from Internet searches.

As more people buy phones with Internet access, the search market is expected to shift increasingly to the mobile Web.

Control of the fledgling mobile search market is still up in the air. With 11 million iPhone customers, Apple Inc. (AAPL) has become a major force in the mobile Internet. Wireless carriers are also seeking a chunk of the business. They don't want to rely simply on monthly access fees for revenue.

The question for Google has been how to best compete in the mobile-search market. Several years ago, the company began to develop its own software for phones and the strategy has started to bear fruit. Most of Motorola's new phones use Android, and Verizon Wireless had made a big splash with the Droid, an iPhone competitor.

"Google has done a good job with Android and getting a lot of manufacturers to support it," said Jagdish Rebello, wireless analyst at iSuppli. "The fundamental object is to monetize the mobile-search market."

Yet those relationships could be threatened if Google challenges handset makers head on. Most would be reluctant to rely on software controlled by competitor. Similar worries deterred many handset makers from adopting Nokia Corp.'s (NOK) Symbian software years ago, analysts point out.

"I don't believe they want to get into the handset business," said analyst James Brehm of Frost & Sullivan. "Why would they want to tick off all their partners?"

Wireless consultant Jane Zweig of The Shosteck Group suggests a rationale: Google doesn't want to let handset makers and wireless carriers act as gatekeepers that control the software customers put on their phones. If consumers can make that choice, like they do with their PCs, Google can bypass the middlemen.

"Google wants to own the customer," said Zweig, one of the few analysts who likes the company's odds of success. "They've always been a mold breaker. Now they are breaking the mold by going straight to the end user."

Tough Mold To Break

Going straight to the customer isn't easy. Most customers have to choose a carrier before they buy a phone because big U.S. operators use different mobile technologies or frequencies. A phone that works on the network of Verizon Communications Inc. (VZ) won't work with AT&T Inc. (T) or T-Mobile or even Sprint Nextel Corp. (S) And vice versa.

What's more, smartphones like an iPhone are expensive to make, costing $500 or more. Handset makers are only able to sell large quantities because carriers offer them to consumers at below cost, typically $100 to $200. In exchange consumers have to agree to a two-year contract.

Google reportedly is mulling a strategy to sell "unlocked" phones that can work on the networks of AT&T or T-Mobile USA Inc. People could buy a Google phone online or in retail stores and then sign up with a wireless carrier.

U.S. consumers are not used to buying phones and wireless plans separately, however, and most are reluctant to shell out big bucks for a new device. Google could offer its phone at a discount if consumers accept a certain number of Internet-based ads, but such a pricing strategy has never worked.

"Google has more expertise in advertising than anyone else in the world, but an ad-supported business model is hard to do. Other companies have tried and failed," said wireless analyst Tero Kuittinen of MKM Partners.

To help spread its costs, Google's best bet is to strike a formal alliance with handset makers even if that means less control, analysts say. The latest talk suggests T-Mobile could agree to a distribution deal with Google.

Google is also limiting its exposure to the hardware business by contracting with Taiwan-based HTC to make the Google phone. That's why many analysts are skeptical Google will dive into the handset business just like Apple, historically a hardware company.

Until the company reveals it full intentions, however, established wireless companies will be on guard. Google's huge size and nearly unbroken string of success on the Internet marks it as a dangerous threat with the potential to reshape the wireless industry.

"The carriers and the handset makers will be nervous," Zweig said.