In several previous posts (“The End of x86“ and “ARM Disrupting Intel with its Business Model“) I examined the potential of ARM-based processors to disrupt the x86 architecture. For a disruption of x86 to take place, ARM technology must progress up-market beyond the embedded and mobile markets, into higher performance computing devices, such as servers, where the x86 architecture dominates. To assess ARM’s progression into the server market, I have organized the following collection of recent and relevant articles:

• Calxeda reveals several important technical details about its ARM-Based servers (March 11, 2011)
• Dell expresses concern about ARM-based servers, could face software issues (March 8, 2011)
• Intel executive responds to recent talk about ARM (and Atom) processors moving up-market into servers (March 1, 2011)
• Intel builds low power server chip based on Atom for SeaMicro, a startup building high density, low power servers (February 27, 2011)
• ARM CEO, Warren East, eager for PC and server expansion (February 1, 2011)
• Microsoft announces that Windows 8 will support ARM architecture (January 5, 2011)
• Nvidia announces Project Denver, to build chips based on ARM “targeting PCs to supercomputers” (January 5, 2011)
• Calxeda promises 10x efficiency gains, half the cost, relative to current x86 servers (November 15, 2010)
• Marvell announces the Armada XP chip, an ARM-based processor for use in servers (November 8, 2010)
• Dell’s Enterprise Products Group prototyping ARM-based servers (November 2, 2010)
• ARM-based server designs “should cost about half as much as equivalent Intel Xeon designs while using only 20% of the power” (November 1, 2010)
• ARM announces the Cortex-A15 design, a high-performance processor with applications in low-power servers (September 8, 2010)
• Smooth-Stone (now Calxeda) raises $48m to build ARM-based servers (August 15, 2010)

Intel’s dominance in the global microprocessor market is being threatened by the rapid rise of ARM Holdings. With its roots in embedded systems and low-end mobile phones, ARM is fast becoming the processor of choice in smartphones and tablets. In addition, a range of companies are now experimenting with ARM-based processors for larger computing devices, from netbooks to servers (e.g., see NVIDIA with Project Denver).

One of the reasons that ARM is gaining share in the processor market boils down to technology. ARM-based chips are more energy efficient than Intel’s. As noted by DataRespons, an “ARM-based system typically uses as little as 2 watts, whereas a fully optimized Intel Atom solution uses 5 or 6 watts.” Energy efficient processors are well suited for portable devices, where battery life is a primary concern. Energy efficiency is also becoming an important issue for non-portable devices, such as servers, because of rising energy costs and concerns about global warming.

Intel is acutely aware of this technological threat posed by ARM, and is aggressively working on developing more energy-efficient processors. Given Intel’s significant technological expertise, the company should be able to close the energy efficiency gap with ARM, if not in 2011 then certainly by 2012.

But what if the threat posed by ARM is not purely, or even primarily, technological? In other words, what if Intel is able to match or even beat ARM-based processors from a technical standpoint (e.g., energy efficiency and clock speed), but continues to lose market share to ARM in all key segments of computing?

Looking beyond technology, ARM Holdings has several other significant advantages that Intel has yet to publicly confront. Each of these other advantages stem from ARM’s unique business model. Unlike Intel, ARM does not manufacture processors and the integrated chips (e.g., system-on-a-chip). Instead, it licenses its processor technology to OEMs who then incorporate this technology into integrated chip designs. The chip designs are then often produced through a contract foundry (e.g., TSMC).

This unique business model gives ARM three significant advantages over Intel. First, with this model, “ARM offers [OEMs] a considerably cheaper total solution than [Intel] can at present…” (DataRespons). Second, this model enables OEMs to customize integrated chips that conform to different form factors. Customization is a major issue for OEMs trying to shave thickness and weight from the latest portable devices, such as smartphones and tablets. Third, this business model, and ARM in general, is less threatening to OEMs. ARM’s business model gives OEMs much more control over design and manufacturing. Moreover, ARM is not weighed down by the baggage that Intel carries as the only producer of x86 processors used in personal computers (PC), aside from AMD.

Intel’s slow response to ARM’s business model could be a significant blind spot. Or it could mean that Intel is unwilling to directly deal with the threat because any serious response would lead to a significant decline in the company’s revenues and profits. Consider that because of ARM’s unique business model, the company generated revenue and operating income in 2010 that was just 1.0% and 0.7%, respectively, of Intel’s. [1]

Intel is still the dominant producer of processors on a global basis, with “86.4% of the [netbook/laptop] market, 93% of the server and workstation market, and 72.1% of the desktop chip market.” The company has significant financial resources and technology expertise to confront competitive challengers. That said, if Intel wants to retain its command over the processor market into the future, as computing shifts away from PCs to connected devices and cloud computing, the company must quickly and decisively confront the significant business model challenge posed by ARM.

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[1] According to Google Finance, ARM’s revenues and operating income in 2010 were $406.6m and $106.96m, respectively. Contrast this with Intel’s revenues and operating income over a similar period, which were $43.6b and $15.463b, respectively.

On Sunday night, Warner Bros. announced that it would become the first Hollywood studio to rent digital movies through Facebook. This move suggests Facebook is working on a broader strategy to further penetrate the media distribution space.  Such a move would be a natural extension for Facebook, given it already stores and shares “more than 30 billion pieces of content (web links, news stories, blog posts, photo albums, etc.)…each month.” This static content is in addition to the thousands of apps that are available via the Facebook Platform.

Meanwhile, just over the weekend, there were reports that Facebook is resuming previous talks with Skype to offer online video calls. This would further extend Facebook into the communication space, with a steady progression from wall posts and the news feed, to online chat, to the recently announced “messages” feature, which combines texts, chat and email. Facebook’s communication network is quickly expanding beyond the confines of the company, through the “Like” button, which allows users to post media directly from many third-party websites.

As Facebook is expanding its service in the directions of media distribution and communication, it’s also expanding further into commerce, with the (beta) introduction of Facebook Credits in 2010. Although Facebook Credits are currently used primarily to purchase items in Facebook apps, it’s likely that the Credits system will soon evolve into a full-blown payment platform to conduct transactions for a range of digital products. Facebook Credits can already be purchased via gift cards at a variety of retailers, from Target to Tesco.

To summarize, it appears that Facebook is advancing in three core directions: media distribution, communication, and commerce. As Facebook moves forward on these three fronts, it will create new competition for the likes of Amazon and Netflix. It will also intensify Facebook’s rivalry with Apple and Google, since these two companies are also aggressively pushing forward in similar areas of technology. Because each of these emerging competitors, from Amazon to Facebook, have roots in very different areas of technology, from online commerce to social networking, we should expect a very dynamic competitive environment over the next 3-5 years. This is good news for online consumers, and bad news for legacy firms and industries.

comScore Reports January 2011 U.S. Mobile Subscriber Market Share

A New York Times article appeared on Sunday with the title: “So Far Rivals Can’t Beat iPad’s Price.”

The iPad 2, unveiled on Wednesday, offers several sleek improvements over its predecessor. But its most attractive feature is perhaps the same one its predecessor had: the price tag. And what makes that feature even more compelling is that so far, Apple’s competitors in tablets cannot beat or even match it.

There are some good points raised in this article, but the title needs to be changed. The title of the article should read: “So Far Rivals Can’t Beat iPad’s Costs.”

Businesses compete on value and on cost. Value is the benefit to the customer (value proposition) and cost is the fixed and variable expenses to the firm for producing that value (cost structure). Value and cost are strategic, and price is a tactical choice that follows from your value-cost position and the competition. If a business offers more value at a given price, relative to a competitor, it will gain market share. If a business has a lower cost at a given price, relative to a competitor, it will have higher margins.

Confusing price and cost has caused the downfall of established companies. For instance, in 2003, Delta launched its Song subsidiary to compete with Southwest Airlines and JetBlue. Delta conceptualized Song as a “low-fare airline,” while Southwest and Jet Blue are low-cost airlines. What happens when you compete with low-prices, but are burdened by the high-cost structure of a legacy airline, such as Delta? Song was disbanded in 2006, after considerable losses.

Will competition in search echo the browser wars between Internet Explorer, Netscape, Firefox, Chrome, Safari, and Opera? The short answer is no. There are tremendous learning effects, economies of scale, and network effects in search that are not present to the same extent, or at all, in the browser market. Let me explain.

Learning effects
The learning effects in the search market arise from the number of searchers and advertisers using a particular search platform over a given period of time. Google, with the largest market share in search (~90% on a global basis), is able to assess and improve its algorithm at a faster rate in response to the behavioral data that it collects from users.

Economies of scale
Substantial economies of scale exist because Google can spread its fixed costs of developing and operating its search engine over a much greater number of searchers and advertisers relative to competitors. For instance, if Google employs 2x the number of engineers as Microsoft in search, but fulfills 4x the number of search requests, its per search engineering costs are 2/4 = 50% of Microsoft’s. The same economies of scale exist for other important fixed costs, such as data center costs.

Network effects
The network effects arise from a feedback loop between searchers and advertisers. As the number of searchers increase on Google search, it attracts more advertisers because advertisers can reach a broader and more targeted audience. The reverse is true as well. As the number of advertisers using Google AdWords increases, it attracts more searchers, assuming that searchers find value in the sponsored search results.

Note that learning effects and economies of scale exist in the browser market, but not at the same level as in search. Meanwhile, there are no obvious network effects in the browser market, while the network effects in search are quite strong. [1]

Google’s dominance
Google’s dominance in search will persist into the future, until:

1. A competitor develops a protectable technology (e.g., new algorithm) or user experience (e.g., superior UI) that delivers significant and unique value to the average searcher and/or advertiser.
2. A substitute for search emerges that provides a more effective method for finding information, which you would otherwise obtain using Google search.
3. Google is unable or unwilling to quickly respond to the aforementioned competitive threats (point #1) or substitution threats (point #2) due to myopia, bureaucracy, etc. Given Google’s rapid response to customer feedback (e.g., concern over content farms) and technology change (e.g., emergence of real-time search), I don’t believe the company is resting on its laurels.

Historical market share data corroborates the above arguments. For instance, despite significant investments by Microsoft, along with some creative and smart decision-making, Bing, with a current global market share of 4.37%, has only been able to gain incremental share in search, primarily at the expense of Yahoo.

As a final note, there is still room for niche search engines, such as DuckDuckGo, to compete by emphasizing unique features of significant importance to a segment of users. For instance, DuckDuckGo does not collect or store a user’s IP address, yielding greater privacy.

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[1] Moderate network effects might exist if we consider browsers and the plugin market.

This past week included two significant events in the emergence of a tablet market. Motorola launched the Xoom last Thursday, the first credible 10” tablet based on Android 3.0, a newly baked Android operating system (OS) optimized for tablets and larger screens. Meanwhile, just yesterday, Apple announced the second iteration of its tablet, the iPad 2, having launched the first iPad almost a year ago, in April 2010.

What does this extra year of learning yield for Apple compared to Motorola and other competitors commercializing their first tablets based on the new Android 3.0?

Aside from incorporating the latest hardware components (e.g., 1 GHZ dual-core processor, front- and rear-facing video cameras), I expect that the iPad 2 will be much more refined than the Xoom and other competing Android-based tablets. The refinements of the iPad 2 will include a superior form factor (lighter, thinner, and more polished), improved battery life, a tightly integrated and bug-free OS, enhanced online services (iTunes), and better accessories. Because these refinements will be focused in areas that are important to tablet customers, they will give the iPad 2 a significant differentiation advantage over the Xoom and any competing tablets. [1]

Looking to the future Apple’s learning curve advantage in tablets will diminish over time as the tablet market matures, since there are limits to incremental refinement within a particular domain of technology. [2] This means that in every subsequent generation of tablets, as competing tablet OEMs (and Google with Android) accumulate knowledge, they will slowly close the differentiation gap with the iPad. However, with the reasonable assumption that Apple continues to accumulate knowledge, it could take years before competitors truly match the refinement of the iPad.

In closing, consider that the first iPhone was announced in January 2007. Four years later, in March 2011, the iPhone arguably still delivers a more refined user experience relative to competing smartphones based on Android and other operating systems. In other words, four years from now, in 2015, the iPad may still have a meaningful differentiation (refinement) advantage over competing tablets. This is astonishing!

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[1] Note that Apple’s time-to-market with the iPad has also yielded advantages in the areas of production efficiency (learning curve in production through FoxConn), supplier relationships, economies of scale, complements (apps), and brand awareness.

[2] Given that Apple maintains tight control over hardware and software, it’s possible that the iPad will be able to maintain a small but meaningful differentiation (refinement) advantage indefinitely into the future.

Tobii Technology Unveils Eye-Tracking Device to Move Cursors

A Swedish technology company is demonstrating new technology at the CeBIT technology trade show in Hannover, Germany today that uses eyeballs rather than a mouse to move cursors on a computer screen, meaning that users can scroll down a Web page or kill bad guys in a videogame with just a look.

In recent years, we have seen the emergence of a variety of innovative user interfaces (UI) for computing devices, such as:

• Dual screen interfaces (Nintendo DS)
• Motion sensing controllers (Nintendo Wii)
• Controller-free interfaces (Microsoft Kinect)
• Multi-touch trackpads (MacBook)
• Capacitive touch-screens (iOS smartphones and tablets)
• Voice recognition (Android smartphones and tablets)

Some of these UI innovations have opened technologies to entirely new segments of customers. For instance, the Nintendo Wii, with the Wii Remote, made console gaming accessible to casual gamers who found it too difficult to learn and operate the controllers for the Microsoft Xbox 360 and Sony PlayStation 3.

Other UI innovations have made possible new, portable form factors for consuming rich media. For example, the Apple iPhone substituted a physical keyboard for a touch-screen. With a large touch-screen, the iPhone could now be used to consume and interface with a variety of content and software, from video to downloadable apps.

Further, select UI innovations have made devices usable in a broader range of life/work settings. For instance, the voice recognition capabilities of Android devices allow users to easily interface with their smartphones in situations where using a keyboard would be inconvenient (e.g., while walking) or unsafe (e.g., while driving).

Looking more broadly, these recent innovations in UI design point to an important trend in computing. As computing moves beyond the PC paradigm, consumers are shifting their attention away from sheer computing power (e.g., CPU clock rate) to a combination of UI and form factor (e.g., size, weight). This shift presents significant opportunities for companies with skill in UI and form factor design (e.g., Apple, Nintendo), and poses significant risks to companies with focused expertise in pushing the frontiers of computing power (e.g., Intel, AMD).

The latest technology platforms, including Facebook, iOS, and Android, have given rise to a vibrant market of third-party apps. This follows the pattern of application development for other popular technology platforms, such as Microsoft Windows. While the basic pattern of application development may seem familiar, there are at least two major differences in the relationship between the latest platforms and the apps, creating substantially more risk for today’s developers.

First, these platforms perform the role of a key supplier, providing user data that is fundamental to the operation of the apps. For instance, Facebook provides Farmville with access to its social graph data; without this data, Farmville would cease to function properly. Second, these platforms perform the role of distribution channel, providing an exclusive marketplace for distributing and selling apps to users. For example, Facebook provides an Apps Directory where a user can find and install Farmville. Farmville then must be played within the Facebook online environment.

By serving as a key supplier and distribution channel, and considering the lack of alternatives, the latest platforms have significant bargaining power over developers. [1]

Consider the flare up between Facebook and Zynga in 2010. Applying its tremendous bargaining power, Facebook sought to impose the Facebook Credits payment platform on Zynga, which included a substantial 30% transaction fee. In addition, Facebook requested that Zynga agree to a long-term deal so that its games would remain primarily on Facebook. When Zynga resisted these terms, Facebook retaliated by shutting off notifications for Farmville and other games. Further, Facebook threatened to “simply shut some of Zynga’s games down permanently.”

How can app developers reduce their risk in this environment? First, developers should support the development of competing technology platforms, especially open source alternatives. Second, developers should port their apps to several popular, competing platforms (e.g., iOS and Android). Third, when possible, developers should create a standalone version of their app that isn’t platform dependent. Fourth, developers should carefully differentiate their apps to cultivate a strong and dedicated following. Lastly, developers should find ways to build and maintain a direct relationship with users.

Let’s return to the Facebook-Zynga example. In response to Facebook’s negotiation tactics, Zynga launched a standalone Farmville application at Farmville.com. During this period, Zynga also began an aggressive campaign to collect email addresses so it could communicate directly with its growing user-base. Further, Zynga quickly diversified its offerings, creating a portfolio of games that operated across multiple, competing platforms, including Facebook, MySpace, iOS, Android, and Yahoo. Because of Zynga’s counter moves, and due to the popularity of its games, Zynga was able to hold the line in its negotiations with Facebook. As important, Zynga has now developed a much stronger bargaining position that it can leverage in any future negotiations.

In closing, while the latest technology platforms present significant opportunities for app developers, they also pose significant risks. These risks stem from the bargaining power of the platforms as suppliers of data and as exclusive distribution channels. To survive and prosper over the long-term, app developers must increase their bargaining power by reducing their dependence on any one platform and by growing and maintaining their distinctive relationship with users.

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[1] This risk is exacerbated because the platforms and their policies are still evolving.

Barnes & Noble: Will It Follow the Borders Plot?

While initial analysis would assume Barnes & Noble will benefit from the bankruptcy of Borders, this may not be the case… Barnes & Noble said it is suspending its 25-cent quarterly dividend to preserve its cash to invest in growing its e-reader business, and declined to provide a fourth-quarter forecast, due to Borders bankruptcy last week.

Now that Borders has filed for bankruptcy it should give Barnes & Noble (B&N) some reprieve and an opportunity to further invest in its emerging digital strategy. Going forward, however, B&N will face at least two significant challenges:

First, B&N generates a majority of its revenues and profits from its bricks-and-mortar retail operations. This revenue and profit will continue to decline as consumer preferences shift away from physical media to digital goods. This shift will place increasing financial pressure on B&N, limiting the company’s ability to fund its major digital initiatives in online media distribution (BN.com) and hardware (Nook).

Second, in the online distribution and hardware markets, B&N must contend with a group of innovative and resource-rich competitors, including Amazon, Apple, Google, and Sony. Each of these companies has significant corporate advantages — in the areas of technology know-how, economies of scale and scope, and brand — that can be leveraged in competition with B&N.

To this point, B&N has exceeded expectations in its ability to transform itself as the market for physical media fades away. For instance, BN.com is holding its own despite significant competition from other online retailers. Further, the Nook has been received well by consumers and critics. Nevertheless, I think B&N faces a very murky future. Investors seem to agree, with B&N trading at close to a 5-year low.