Complete Open Phone Manifesto

It has long been assumed that product innovations are typically developed by product manufacturers … However, it now appears that this basic assumption is often wrong. -- Dr. Eric von Hippel, Sources of Innovation

The World As We Find It

For years many of us in the mobile phone "value chain" have been waiting for a truly revolutionary device. A device that would solve all of our problems for dealing with a hectic world. Many devices have come close: the Handspring / Palm Treo, the Motorola Q, and a host of devices running Linux, SymbianOS and WindowsCE. Each of these products has it's benefits and value, but each comes with it's own problems. But the biggest problem of all is there's nothing the end user can do to fix the myriad of minor annoyances that come with the device. Actually, there's nothing the end user can do to fix the major annoyances that come from the device. That's because most mobile devices come as "products" and not "platforms." In short, the device is a "take it or leave it" proposition. You accept the annoyances to get the benefits, or you just don't buy it. The goal of the mobile device industry is, and has been for a long time, to build a product that appeals to the largest possible market. There are many reasons that the mobile value chain has evolved this way:

• allowing end-user tinkerer to "open up" the platform could lead to increased support costs.
• malicious end-user tinkerer could potentially abuse the mobile device networks.
• "locking down" the device also gives the network operator and the device manufacturer enhanced control over the market and business partners.
• and in the end, the thing that's most important to most people is the ability to send and receive phone calls.

And let's not forget that the network operators have been doing a pretty good job of connecting phone calls. To be sure we get dropped calls and the user interfaces on the supported devices can be "less than optimal." But when you consider that a small device that weighs less than a pound is able to maintain (for the most part) a conversation with a cell phone tower up to a mile away and seamlessly hand off the call to the next tower when you're moving about and you get this service for as low as $50.00 per month; it's not a bad deal. However... There is a price we pay for the closed nature of these phones.

"Locking down" mobile phones means end users benefit only from those services supported by the network operators and the handset manufacturers. While many of these services are of high quality, some fall short of the mark. While we can expect a few stumbles on the road to technological nirvana, it does seem that the operator's need to control actively discourages experimentation that leads to innovation.

The core philosophy of the mobile industry's product strategy, to provide a product that appeals to the broadest possible market, ensures that motivated lead users will receive satisfactory products only by accident, if at all.

Problems In The World

In his 1988 text, Sources of Innovation, author (and MIT Professor) Eric von Hippel investigates the processes by which new products are introduced to the market. In the text von Hippel examines the role of "lead users." Lead users have the characteristic that: (from p. 107, "Sources of Innovation," von Hippel):

1. Lead users face needs that will be general in a marketplace, but they face them months or years before the bulk of the marketplace encounters them, and
2. Lead users are positioned to benefit significantly by obtaining a solution to those needs.

Since lead users often predict future market demand and have a budget to pay for the development of innovative new services and products, you would think that manufacturers would be falling over themselves to include them in their product planning processes. While it is true in some cases, it is often not the case. Businesses with a successful, "Cash Cow" product are tuned to convince the market that customers should adapt their requirements to meet the product's capabilities. And this is a sensible thing for a manufacturing firm. Many of our most valuable products require substantial capital investment. To realize a return on that investment, manufacturers must spread the up-front costs across many sales. As there is typically a cost associated with retooling an assembly line to produce a new product variant, businesses must judge which path will lead to increased profits: retooling an existing product to meet a new customer's requirements or try to convince the customer that a "stock" product will meet those requirements.

It's no surprise to hear that it's generally less expensive to try to convince customers to buy a "stock" product.

We tend to view high-tech marketplaces as venues for Darwinian selection. Companies with innovative new products that fill a need or a niche continue to be successful while those with bad products fall by the wayside. Noted computer scientist Dick Gabriel reminds us in his text Models of Software Acceptance that sometimes evolution can be a problematic model for some companies (From p. 21 of "Models of Software Acceptance," Gabriel):

At a molecular level, natural selection prevents change.

and from p. 25:

"Natural selection prevents change by choosing what survives, which is almost always what has survived before because environmental change is slow... What is free to change is not crucial to survival."

And this is why suppliers tend to be loathe to allow customers to dictate product design decisions. Companies that survive are ones that supply a good or a service that is in demand. Convincing these companies to change their product after they have survived with it for several years is like asking a fish to crawl out of the water or a sharp-toothed dinosaur to take up wings instead of teeth. While it may be apparent that it's a long-term success strategy, it's unclear that it will help us close sales this quarter.

So we find ourselves in a world where the forces of industrial capitalism have driven the mobile phone marketplace towards increased consolidation. Fewer market actors are chasing larger revenues by reducing the cost-per-customer (and thus increasing the market size and total revenues.) Average margins are going down, but that's okay as long as revenue growth continues faster than costs.

The Coming Mobile Apocalypse

If we look around in the modern times, we see very few dinosaurs. Conventional wisdom is they were wiped out by an asteroid strike at the Cretaceous-Tertiary boundary some 65 million years ago (see The Extinction of the Dinosaurs in North America by Fastovsky and Sheehan.) But Gabriel points out (on page 24 of "Models of Software Acceptance") that:

Dinosaurs and mammals overlapped by 100 million years, plenty of time for any wedge-related competition to have increased the mammals' niche or even forced out the dinosaurs if the mammals were so much better than the dinosaurs. However, it took a disaster -- currently believed to be a comet or an asteroid hitting the earth -- to dislodge the dinosaurs.

It might be instructive to think of the current marketplace as being the "Cretaceous Period." We have a few large dinosaurs roaming the landscape and a number of little mammals surviving in particular niches. This will continue until some crisis causes marginal costs to exceed marginal revenue. When this happens, revenue growth will stop unless "the dinosaurs" change their service and product mix, or change the market.

You can take a couple views with respect to the upcoming crisis:

1. You can deny it will happen, and not worry about surviving it.
2. You can accept that it will happen, but will deal with it when it happens and hope that you survive.
3. You can prepare for it, and hope that you survive.

Be A Mammal or Grow Wings

One way to survive the apocalypse is to become a mammal. In this context, that means discounting the business history of the 19th and 20th centuries and effectively turning ones back on capital-intensive products aimed at the mass-market. Instead, you would find a small niche and cling to it like there's no tomorrow. The other way is to continue to be a dinosaur, let the asteroid hit and then pray that one of your mutated offspring survives.

An increasing number of businesses are looking at the mammalian business model. Chris Anderson's "The Long Tail" and it's associated Long Tail Blog have been discussing the economics of niches. The key point of Anderson's message seems to be the market value of the aggregated long tail, niche products seems to exceed the market value of the short head, mass market products. In short, there's money in niches, but if you go about it in a business as usual manner, the cost-per-sale might be too high to make the niches interesting. Successful mammals are not "business as usual" creatures, though. They're experimenting with online commerce, requirements aggregation and even open source business models. They're using newly developed tools to drive down cost-per-sale and drive up margins.

Key to long tail products is the concept of "Mass Customization." The idea that industrial processes may be re-tuned to create a large design space while reducing the cost-per-change. You keep the concept of the capital-intensive factory producing widgets whose non-recurring design costs must be recovered, but you add a layer of "Lean Manufacturing" that drives down inventory costs and reduces the impact of design changes on aggregate cost. Many people have heard about the "Just In Time" manufacturing techniques championed by Taiichi Ohno at Toyota. "Mass Customization" marries JIT manufacturing with low-cost demand aggregation (with "Activity Based Costing" to keep the accountants happy) to provide an cost-effective vehicle for meeting demand from "long tail" markets.

Dinosaurs and their Mammal Friends

In the Cretaceous mobile market, the dinosaurs rule. But they do so by concentrating on the mass market and leaving the niches to the mammals. For the most part the dinosaurs ignore the mammals and the mammals try not to get squashed. But if there's an asteroid heading our way, it's possible to define a symbiotic relationship.

Financial managers will frequently speak of the Capital Asset Pricing Model (CAPM) or the Black-Scholes Option Pricing Model. They're both mental frameworks for trying to find a fair price for a "security." In the case of CAPM, it's an attempt to find the risk and reward contributed by a stock in a well-diversified portfolio. Black-Scholes helps expose a fair price for an "option" on a security.

Most dinosaurs have financial managers with an intuitive understanding of these models. If you view the mammals as a business venture that could potentially survive an asteroid strike (and even thrive,) keeping them around might be in the dinosaurs' enlightened best interests. If dinosaurs provided protection for the mammals in the near term, they could ask for a piece of the action in the post-asteroid market.

Put another way, it's hard to predict what the next killer app will be. But small enterprises that focus on niche markets may have an advantage in discovering it. Small businesses that are "close to the customer" will understand a product and service mix that will meet their customers' demands. Service businesses, with low start-up capital requirements, are relieved from the pressures of amortizing NRE costs across sales. They can spend the time to understand the dynamics of their customer's problem space. This understanding can be valuable for product companies if that niche grows into a mature market.

So if the dinosaurs invest in a collection of mammal business plans, they effectively buy an insurance policy against irrelevance in the post-asteroid world. Even if none of the niches grows into a large market, the dinosaurs still own a piece of the action in the mammal markets. The worst that could happen would be that all the mammals in the portfolio die, but modern portfolio theory instructs us to select a diverse portfolio; one that is risk resistant.

When Will the Asteroid Strike?

In a way, we've already seen an asteroid strike or two. The early years of the mobile device market were characterized by a wide array of hardware manufacturers (Motorola, Sony, Ericsson, Nokia, Kyocera, etc.) and a large selection of network operators (VoiceStream, AT&T Wireless, Sprint, Nextel, Macaw Cellular, etc.) Together they provided mobile voice communications. As product demand grew, they competed on service and price. In a few years, as margins decreased and cost-per-customer increased, some were unable to continue operations. Nextel merged with Sprint. Sony's mobile phone operations merged with Ericsson's to produce Sony-Ericsson. Siemen's sold their mobile handset business to BenQ.

The previous apocalypse was a cost-related crisis. Companies that could not drive down costs fast enough were bought by larger companies with deeper pockets or better cost-containment policies. This was the dynamic in a growing market. The industry met increasing demand with lower cost products and thus grew their market by appealing to a larger customer base.

But mobile device adoption growth is showing signs of slowing. In the new market, companies will compete on the basis of features (in the US markets) and experience (in the European markets.)

At some point, earnings growth from new-customer-sales in the US or in Europe will approach zero. When it does, we will have reached the limit of cost containment from the supplier side. To be sure there's plenty of room to squeeze a few more percentage points of efficiency, perhaps in managing the supply chain or mobile advertising. But when you can no longer grow your market by reducing costs, you'll have to compete based on features, services and "experience."

When this happens, we will know the asteroid has hit.

So What Does This Have To Do With Cell Phones?

Competing on the basis of cost has a limited lifetime. Competing on the basis of service quality, experience or features also has a limited lifetime, but it has a lifetime that's likely to outlive the low-cost players.

But there's a problem in the world of the traditional players... These companies have been structured to minimize cost, not maximize innovation. In order to achieve economies of scale, traditional players like Nokia, Motorola and Sony-Ericsson are still selling into mass markets. In the US, the dominance of the network operators has led these company's product management teams to focus almost exclusively on the major carriers (Verizon, AT&T/Cingular, Sprint/NexTel and VoiceStream/T-Mobile.)

So who's getting close to the customer? Google, Yahoo!, BlackBerry, Good and a constellation of "mom & pop shops" that know their market niches.

Earnings growth in the mobile marketplace after 2009 will come from companies who know how to layer "value add" services on top of mobile platforms. These small innovators are the ones who will know how to make a profit. They are the ones that are "tuned into" the niche market requirements that will produce sufficient value for customers; enough value to warrant higher service costs.

At the Homebrew Mobile Phone Club, we don't know which niches will produce the next great "killer app." It could be that none of them will. Perhaps the next "killer app" is simply the ease with which existing technology can be modified to meet specific niche requirements.

But we do know that the value in the mobile market place isn't going to come from producing "one size fits all" products and services. The value will come from "higher up the food chain" where service companies integrate mobile technology into their service offerings or individual innovators directly apply their knowledge of a market and technology to solve problems.

The club is about bringing people together to develop toolkits individual innovators use to solve next generation business problems and to build cool mobile devices.

As part of our mission, we're working on a series of "complete open phone" designs. These designs are distributed under creative commons and open source licenses. Their value is derived from their open nature. Innovators are free to select as much of the complete open phone designs as they wish to use to create a solution.