Is loss leadership a threat to innovation?

GoogleEvery January since 1978 thousands of technology enthusiasts have descended upon Las Vegas. Some say their motives are to gamble away their millions made from another bumper Christmas, with tablet and smartphone sales soaring even further than before in Q4 2012, but to most following consumer technology ‘January’ and ‘Las Vegas’ can be replaced with a simple, three letter acronym: C.E.S., the Consumer Electronics Show.

I have only ever visited one trade show, the slightly less well known Optrafair, where all of the British optical community gather to gawp at the latest innovations in … optics. Attending Optrafair with my parents (who are both optometrists) was hardly the most riveting experience of my two decades, but I came away with two very distinct memories which seem to serve as a very good generalisation for trade shows: salespeople are almost exclusively very attractive (and normally female) and every single product being shown is the best thing since soft contact lenses (or the industry equivalent to sliced bread).

I am reliably informed that CES is hyperbolic of even the traditional trade-show narrative … ‘booth babes’ (no longer just above average looking salespeople, but scantily clad models half trained to sell, half trained to shamelessly flirt) and product announcements which can only be described as the opposite of subtle are both found in abundance.

I am by no means the only one giving CES a bad rep. Many bloggers and journalists are claiming that they won’t make the annual pilgrimage to the city that never sleeps this time next year, even if it is an all expenses paid trip with hundreds of freebies and product demos (and models) which most would think would attract most geeks without quibble. Things must really be bad if people would rather be lounging at home suffering from post-Christmas lethargy than heading to the event of the year in their respective industry, in Las Vegas of all places.

Aside from all of the moaning and metajournalism, there were actually some fairly exciting product announcements at CES this year: Sony finally appears to be making a comeback in the mobile space after parting ways with Ericsson with the launch of their ‘waterproof superphone’ the Xperia Z, and Vizio announced a tablet which they claim is lighter, thinner and more powerful than Apple’s king of the tablets.

Both devices appear to be competitively specced when compared to the current crop of high-end devices, since both are running the latest iteration of Google’s Android operating system and feature excellent displays, processors and the like. Crucially both devices also appear to be competitively priced when compared to Apple’s latest offerings: Sony’s Xperia Z is estimated to come in at around £530 without a contract which is the same as Apple’s basic model of the iPhone 5, and although Vizio have not revealed pricing information they have said it will be in line with the latest iPad, which comes in at £399 for the base model.

I was quite excited about these announcements because I am currently shopping around for a tablet or laptop and potentially a new phone if I have any change. Most of this will be financed from my Christmas holiday work, but also my parents have agreed to top up my fund as a Christmas present should I convince them that I have found the best tablet to suit my needs.

On the surface these two devices appear to be perfect for me: I am heavily invested in Google services and so I won’t consider jumping ship to Apple or Microsoft unless they offered something really enticing. But I’m afraid to say that I’ll be passing on Vizio and Sony too. If you asked me this time last year when one should look to upgrade personal electronics, I would have said some time after CES so that you can jump on the latest and greatest. I’m not turning Sony and Vizio down because they’re failing to offer really, really good products, but rather because they’re really, really expensive. No, obviously not expensive when compared to Apple, but definitely, completely, blatantly overpriced when compared to the offerings of Google, and to some extent Amazon.

I’m sorry for doing this in such a roundabout way, but I wanted to give some context for why the business model that Google and Amazon are pursuing is so outlandish. Google’s latest ‘Nexus’ phone (Nexus is a line of devices curated by Google, the manufacturers have little to no say in how the final product comes out, they just make it to Google’s specifications) is called the Nexus 4, and it compared very favourably to the iPhone 5 in most departments. It is probably a less enticing phone than the waterproof Xperia Z, which comes with a better screen and camera, but whilst the Sony and Apple are asking for around £530 to lay your fingers on their handsets, Google are asking for just £280 (and there’s a lower end model with half the storage for £240, less than half the price of the others).

It’s a similar, if less dramatic story with tablets. Google’s Nexus 10 costs £80 less than the base ‘iPad with retina display’, and we assume the same will be true of Vizio’s tablet. Apple enthusiasts might argue that the iPad 2 or the iPad mini are more similarly priced, but Google’s smaller offering (the imaginatively named Nexus 7) starts at over a hundred pounds less than the brand new iPad mini.

Amazon is tipped to enter the mobile phone market with a device similar to Google’s Nexus 4, but Amazon was actually the first company to substantially undercut Apple in the tablet market with their Kindle Fire, which is priced similarly to the Nexus line. Nexuses and Amazon’s offerings appear to make Apple’s products – and especially new efforts by companies like Vizio, Samsung and Sony – look incredibly expensive. I am not looking to start an argument about whether these products are overpriced or not, I wholeheartedly believe that if you are invested in a brand and you enjoy using it then you’ll need a very good reason to win you over to a new ecosystem, but the price differences are undeniably substantial. What I want to comment on is how this behaviour seems great for consumers on the surface, but could actually be very damaging in the long term.

Once the Nexus 4 and Nexus 10 eventually come back in stock (they have been sold out since virtually their first day of release), I am 99% sure I will go ahead and buy them. I’ll even have some change leftover for an external monitor and a Bluetooth keyboard so that I can write essays on my Nexus 10.  However, when I pitched this master plan to my parents they could not understand how Google’s offerings are so much less expensive than the other options on offer. They insisted there must be a catch. I showed them that the build quality, software and performance were reported to be in the same league as the much more expensive alternatives. Eventually they were won over and assumed Google must have some voodoo powers which enabled them to create more affordable products.

Despite winning my parents over, a seed of doubt had been planted in my mind. How on earth can Google, and Amazon, afford to charge such a little amount for devices which would appear to cost much more if they simply had a different name badge on them? Google have been quite shady about the whole thing, but with a little digging it became apparent that Amazon have been pursuing this tactic for quite some time in the plain light of day.

Amazon’s tablet range is intended to deliver devices that make enjoying Amazon’s many services seamless and fool proof. Most people know about Amazon’s Kindle store for buying ebooks. It turns out that Kindle books are incredibly easy to download and consume for all Kindle Fire owners. Amazon also offer easy access to MP3s, digital videos, cloud storage (like Dropbox) and apps via the Kindle Fire, as well as a superior product browsing experience for Amazon’s main storefront physical which so many people rely on for a vast array of products. Amazon’s strategy for the Kindle Fire is plain: recuperate reasonable costs from selling the device, but use the device to facilitate dependence on Amazon’s ecosystem, and Amazon’s ecosystem alone. If you use the Kindle Fire as intended, you basically only use Amazon’s services for most of your digital life, all of which it profits from.

This strategy isn’t new or unheard of. The normal just-plain-old-reading Kindles are sold at or close to cost, with the hope that you’ll buy enough books from the Kindle store to make it worth Amazon’s while, and they’ve been around since 2007. Sony appear to be the victims of this aggressive pricing strategy because their Xperia Z is so dramatically undercut by the Nexus 4, but Sony behaved in exactly the same way with their Playstation line of games consoles, often profiting off the game sales rather than the console itself.

The strategies can easily be observed outside of the world of technology too. Harry Potter and the Deathly Hallows was sold at a loss by all major retailers. Supermarkets lead the charge, but WH Smith and Waterstones were forced to follow by charging less than cost in the hope that avid readers might also snap up some other books whilst they were in store.

This is clearly the sort of strategy that Amazon are pursuing, but by no means limiting their services to books. A lot more is at stake than just peripheral book sales in the all inclusive world of digital services.

Google have been a little shady about the whole thing. Google’s Android software is given away for free to manufacturers to do with as they please. Manufacturers generally choose to keep Google’s search, Gmail and application store in order to deliver the best experience, whilst profiting from the sale of the physical devices themselves. In this model, Google makes money from the app store and people’s reliance on other Google services which just happen to come with the handsets. Google then released the Nexus line of devices, which it claimed were to show manufacturers how Google envisioned Android to look on a phone. Google made it very clear that the aim was not to make lots of extra money or to compete with its hardware partners, but rather to set standards and spark new ideas. But in light of Google’s most recent releases I honestly can’t believe this is Google’s strategy any more. Releasing devices so competitively priced cannot be seen as working well with anyone other than the few manufacturers who are actually making the new Nexus lines. Everyone else is left in the dust whilst Google charges what they want knowing that as long as that person buys a few apps, books, MP3s, movies or magazines from Google’s ‘Play’ store they will have made enough money to justify the whole thing.

I’d love to conclude this article by righteously declaring that Google and Amazon are awful, uncompetitive companies who are trying to stifle competition through loss leadership, and that I will therefore abstain from buying any new devices until their pricing strategies change, but I can’t bring myself to say it. Perhaps I’m just trying to rationalise my selfishness by saying that at least Google are trying to stay open by allowing competitors present services on their app store, and that Amazon are such underdogs in the market right now that their pricing strategy might give them the leg up they need to actually challenge Apple.

A small part of me really is very worried that such aggressive pricing will eventually lead to smaller fish (like Vizio and Sony) being pushed out of the market, which could eventually stifle the innovation that choice brings to the table, but I’m afraid to say my bank balance is much smaller, and my thirst for the latest technology is much greater, than that part of me will be for the foreseeable future.