Alphabet Inc Getting More Serious About Hardware Is A Smart Move

  • Google has hired former Motorola president to head a brand new hardware unit at the company.
  • Google is trying to unify its diverse hardware offerings under one umbrella to help it integrate them more tightly into its ecosystem.
  • This might help Google expand its hardware footprint and stop relying too heavily on Apple to drive its mobile fortunes.

At its core Alphabet Inc (NSDQ:GOOG) has always been a software/ad company while hardware had always remained on the fringes. Google does have some hardware footprint including smart home devices courtesy of its Nest Labs and Dropcam acquisitions, Chromebooks, and Nexus smartphones. But unlike Microsoft, Google does not make the hardware directly. In any case, Google's direct hardware sales really are a drop in the proverbial bucket--Nest Labs brought in $340M, or less than 1% of the company's revenue, in 2015. Google does not share details of revenue from Nexus phones and Chromebooks.

Also read: Should Investors Buy Alphabet Inc After Its Earnings Miss?

In contrast, Microsoft (NSDQ:MSFT), one of the largest software companies in the world, has more than 40% of its revenue coming from hardware ranging from consoles and smartphones to laptops and virtual reality devices. Former Microsoft CEO Steve Ballmer famously predicted that Microsoft would become a major hardware company in the future--and he was right. Microsoft's Xbox gaming consoles and Surface devices are among the best-selling in their product category while HoloLens VR devices promise to become a hit.

But Google now plans to change its approach to hardware. The company has reportedly hired former Motorola president Nick Osterloh to head a brand new hardware division at Google. Osterloh's job description involves unifying diverse Google hardware products including its flagship Nexus phones as well as trying to revamp the failed Google Glass. The new hardware division had never before existed at the company. Google currently only oversees the design, development and marketing of Nexus phones but relies on smartphone OEMs including Huawei, HTC, and LG to do the actual manufacturing.

But Google is now looking to adopt an Apple (NSDQ:AAPL)-like strategy where it adopts a hands-on approach to its hardware and takes a more end-to-end control of the product chain. For instance by taking more control over Nexus, Google can try to make the smartphone identifiable with its brand just like iPhone is synonymous with Apple. With its own smartphone, Google could be in a better position to entice people to use services such as search and Maps more, and reduce its reliance on Apple to drive its mobile revenue.

Also read: Alphabet Inc Brings VR Video Closer To Reality On Youtube

Google certainly relies a bit too heavily on Apple devices to drive its mobile top line. Goldman Sachs estimates that close to 75% of Google's mobile search revenue can be traced back to Apple devices including iPhones and iPads. By integrating Nexus more tightly with its own ecosystem, Google would have a better chance to gain more control on its mobile revenues. Google currently uses Nexus phones as the flag bearer of the company's innovation for Android. Nexus is regarded as a pure Android smartphone with no software tweaks from manufacturers. Google has mostly used the phone as an experimental platform to learn what people want in their Android phones.

Microsoft does the same with Surface since it tries to use the skinny laptop as the standard for Window laptops and as an inspiration to third-party OEMs to encourage them to make more attractive Windows devices. But unlike Google, Microsoft has now managed to build Surface into a $1B+/quarter business. There is really no good reason why Google cannot achieve the same with something like Chromebooks.

In any case, this could be Google's chance to build a successful business outside its core search business. Most of Google's moonshot projects have failed to really take off as hoped, despite gobbling up huge sums of R&D cash. It will probably be easier for Google to build a successful laptop/smartphone hardware business than it will be to make money from its speculative projects.

Investor Takeaway

Google has never developed a proper hardware footprint. But this could change once the company tries to unify its hardware products under a single unit. This could help Google to stop relying too heavily on Apple devices for its mobile search business and Google might even succeed in building a thriving hardware business.

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