If there’s one thing that Apple (NASDAQ:AAPL) has proven, it’s that deep vertical integration between hardware and software, when done right, can be more successful and profitable than you can imagine.
That’s a stark contrast to the PC era, when modularity and a fragmented value chain won the day. Microsoft (NASDAQ:MSFT) emerged victorious in the war for the PC, and Alphabet‘s (NASDAQ:GOOG) (NASDAQ:GOOGL) Google has mostly used the same playbook to capture the smartphone market with Android, at least in terms of unit share. Yet Apple has reaped incredible profits thanks to the iPhone, demonstrating that its model was just as — if not more — viable when it comes to financial performance.
But do you remember when Google and Microsoft both wanted to make their own phones, losing billions in failed acquisitions? Let’s take a trip down memory lane.
It might seem like ancient history since it happened over five years ago, but do you recall when Google shocked the tech world when it announced in August 2011 that it would acquire Motorola Mobility? The massive $12.4 billion deal raised more questions than it provided answers.
What would Google do with the set-top box division? Lacking meaningful hardware experience, would the search giant really be able to integrate Motorola’s operations? Wouldn’t that put off other handset partners? Would investors tolerate significant margin dilution, considering Motorola’s operating losses? Was Motorola’s intellectual property (IP) portfolio really that valuable? What was the most appropriate portmanteau to use to reference the combined company?
Of course, Google ended up selling off Motorola to China’s Lenovo just three years later in 2014 — for just $2.9 billion. There was initially about $2.9 billion in cash acquired, bringing Google’s net cost down to about $9.5 billion. Google later sold the set-top box business to Arris for $2.35 billion. After fetching $5.25 billion between both sales, Google lost “only” $4.25 billion. That’s actually less than the $5.5 billion worth of patents and developed technology that Google accounted for when it finalized the figures. The deal was always predicated on patents, which Google kept as souvenirs.
But that doesn’t include the billions in operating losses that Google absorbed for the three years that it owned Motorola (I recall counting cumulative losses of $1.4 billion through Q1 2013, about a year and a half before Lenovo closed its deal). It’s safe to say that overall the Motorola episode was a costly mistake.
Unlike Googorola, it was always clear that Microkia was the best portmanteau to use when referencing Microsoft’s $7.2 billion acquisition of Nokia‘s handset business in 2013. At that moment in history, it had become painfully obvious that no one else wanted to make Windows Phones anymore, and Nokia was consistently operating in the red. It probably wasn’t a coincidence that Nokia’s CEO at the time, Stephen Elop, had come from Microsoft. If Windows Phone were to have any chance, the software giant would need to help support Nokia’s handset business in some way. Microsoft chose to buy it.
Less than two short years later, Nokia would become the latest in Microsoft’s string of failed blockbuster acquisitions, resulting in an incredible $7.6 billion in write offs. (In fact, the restructuring was announced just over a year after the deal closed.) Yup, Microsoft wrote off more than 100% of the initial deal’s value. The restructuring was the last vestige of former CEO Steve Ballmer’s legacy, as he had been the primary advocate for the deal. Ballmer recently revealed that the move created considerable tension with his longtime friend and colleague Bill Gates.
Hardware is hard
We’re talking about billions of dollars of shareholder value destruction, spawned in part from wanting to be like Apple. For what it’s worth, Googorola was also a defensive patent play, as patent litigation was all the rage in smartphones back then. Despite these past mistakes, both Google and Microsoft continue to push deeper into hardware.
With the recent introduction of the Pixel, Google is more of a smartphone maker than ever before in some ways. Pixel is the first phone to be completely designed by Google — and not through a collaborative third-party OEM or a subsidiary. But I consider Pixel to be a spiritual successor to the Nexus program, and Nexus devices were never meant to be high-volume products. Nexus and Pixel are intended to showcase what Android can do, and I don’t believe Google intends to make Pixel a high-volume product, either (although some analysts think Pixel could become a $3.8 billion business next year).
Microsoft still makes phones, but its unit volumes have long been dominated by “dumb” feature phones. The company is in the process of selling the feature phone business to Foxconn for a mere $350 million, which is still on track to close this quarter if it hasn’t already. Instead, the software giant is making a big push into PCs and tablets with its Surface family of devices. Like Google, the extent of Microsoft’s current hardware operations is unprecedented.
The moral of this story is something that Silicon Valley has known all along: Hardware is hard.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.