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I like to think of myself as an aficionado of business disruption. After all, as a venture capitalist it is imperative to understand ways in which a smaller private company can gain the upper hand on a large incumbent. One of the most successful ways to do this is to change the rules of the game in such a way that the incumbent would need to abandon or destroy its core business in order to lay chase to your strategy. This thinking, which was eloquently chronicled in Clay Christiansen’s The Innovator’s Delimma, is the key premise behind recently successful business movements like SAAS (Software as a Service), open source software, and the much-discussed Freemium Internet model. And while each of these disruptions are impressive in their own right, when I read this week that Google was including free turn-by-turn navigation directions with each and every Android mobile OS, I had an immediate feeling that I was witnessing a disruptive play of a magnitude heretofore unseen.

Google has long had an interest in maps. Early in its history, the company added “Maps” as one of the coveted tab alternatives offered at the top of the screen above its famed search box. At that time, Google did what many others did to enter the mapping business – they licensed data from the two duopolists that ruled the mapping business – Tele Atlas and NavTeq. Over the years, as these two companies gained more and more power, and larger and larger market capitalizations, Google’s ambitions were growing too. Google wanted to spread its maps across the web, and to allow others to build on top of its mapping API. The duopolists, recognizing a fox in the henhouse, were apprehensive to allow such activity.

In the summer of 2007, excitement regarding the criticality of map data (specifically turn-by-turn navigation data) reached a fever pitch. On July 23, 2007, TomTom, the leading portable GPS device maker, agreed to buy Tele Atlas for US$2.7 billion. Shortly thereafter, on October 1, Nokia agreed to buy NavTeq for a cool US$8.1 billion. Meanwhile Google was still evolving its strategy and no longer wanted to be limited by the terms of its two contracts. As such, they informed Tele Atlas and NavTeq that they wanted to modify their license terms to allow more liberty with respect to syndication and proliferation. NavTeq balked, and in September of 2008 Google quietly dropped NavTeq, moving to just one partner for its core mapping data. Tele Atlas eventually agreed to the term modifications, but perhaps they should have sensed something bigger at play.

Rumors abound about just how many cars Google has on the roads building it own turn-by-turn mapping data as well as its unique “Google Streetview” database. Whatever it is, it must be huge. This October 13th, just over one year after dropping NavTeq, the other shoe dropped as well. Google disconnected from Tele Atlas and began to offer maps that were free and clear of either license. These maps are based on a combination of their own data as well as freely available data. Two weeks after this, Google announces free turn-by-turn directions for all Android phones. This couldn’t have been a great day for the deal teams that worked on the respective Tele Atlas and NavTeq acquisitions.

To understand just how disruptive this is to the GPS data market, you must first understand that “turn-by-turn” data was the lynchpin that held the duopoly together. Anyone could get map data (there are many free sources), but turn-by-turn data was remarkably expensive to build and maintain. As a result, no one could really duplicate it. The duopolists had price leverage and demanded remarkably high royalties, and the GPS device makers (TomTom, Garmin, Nokia) were forced to be price takers. You can see evidence of this price umbrella in the uniquely high $99.99 price point TomTom now charges for its iPhone application. When TomTom bought Tele Atlas, the die was cast. Eat or be eaten. If you didn’t control your own data, how could you compete in the GPS market? This is what prompted the Nokia-NavTeq deal.

Google’s free navigation feature announcement dealt a crushing blow to the GPS stocks. Garmin fell 16%. TomTom fell 21%. Imagine trying to maintain high royalty rates against this strategic move by Google. Android is not only a phone OS, it’s a CE OS. If Ford or BMW want to build an in-dash Android GPS, guess what? Google will give it to them for free. As we noted in our take on the free business model, “if a disruptive competitor can offer a product or service similar to yours for ‘free,’ and if they can make enough money to keep the lights on, then you likely have a problem.” It would be one thing if this were merely a mean-spirited play by Google to put an end to the GPS data duopoly. But it is not. There are multiple facets to this remarkably disruptive move.

While it is obvious that this maneuver creates a problem for the multi-billion dollar GPS market, it also poses real challenges for the leading smart phone players – RIM’s Blackberry and Apple’s iPhone. Without access to their own mapping data, these vendors now face an interesting dilemma. Do you risk flying naked without free navigation or do you suck it up and swallow the above average royalty fee for each and every handset? Neither option is stellar. This problem isn’t nearly as daunting as the one now faced by the Windows Mobile and Symbian teams. As software providers, they are lucky to get a per unit royalty equal to that extracted by the GPS data guys. If they are now forced to integrate this data merely to keep their product competitive, their gross margin just went negative. Ouch!

This is not just incredible defense. Google is apt to believe that the geographic taxonomy is a wonderful skeleton for a geo-based ad network. If your maps are distributed everywhere on the Internet and in every mobile device, you control that framework. Cash starved startups, building interesting and innovative mobile apps, will undoubtedly build on Google’s map API. It’s rich, it is easy to use, and quite frankly the price is right. In the future, if you want to advertise your local business to people with an interest in your local market, chances are you will look to Google for that access.

Introducing the “Less Than Free” Business Model

Google’s brilliance doesn’t stop there. It is hard not to have been surprised by the rapid rise in recent buzz surrounding the Google Android Smartphone OS. When I asked a mobile industry veteran why carriers were so willing to dance with Google, a company they once feared, he suggested that Google was the “lesser of two evils.” With Blackberry and iPhone grabbing more and more subs, the carriers were losing control of the customer UI, which undoubtedly represents power and future monetization opportunities. With Android, carriers could re-claim their customer “deck.” Additionally, because Google has created an open source version of Android, carriers believe they have an “out” if they part ways with Google in the future.

I then asked my friend, “so why would they ever use the Google (non open source) license version.” (EDIT: One of the commenters below pointed out that all Android is open source, and the Google apps pack, including the GPS, is licensed on top. Doesn’t change the argument, but wanted the correct data included here.) Here was the big punch line – because Google will give you ad splits on search if you use that version! That’s right; Google will pay you to use their mobile OS. I like to call this the “less than free” business model. This is a remarkable card to play. Because of its dominance in search, Google has ad rates that blow away the competition. To compete at an equally “less than free” price point, Symbian or windows mobile would need to subsidize. Double ouch!!

“Less than free” may not stop with the mobile phone. Google’s CEO Eric Schmidt has been quite outspoken about his support for the Google Chrome OS. And there is no reason to believe that the “less than free” business model will not be used here as well. If Sony or HP or Dell builds a netbook based on Chrome OS, they will make money on every search each user initiates. Google, eager to protect its search share and market volume, will gladly pay the ad splits. Microsoft, who was already forced to lower Windows netbook pricing to fend off Linux, will be dancing with a business model inversion of epic proportion – from “you pay me” to “I pay you.” It’s really hard to build a compensation package for your sales team on those economics.

Naysayers of these assertions will likely have the same retort – quality is key. They will argue that Google’s turn-by-turn apps are inferior to their well honed market leading products. With regard to Android, Google will lack the user interface or embedded software expertise necessary and will deliver a subpar product. Plus, because the Android OS will be so splintered, QA testing will be difficult and incompatibility issues will abound. In the short run, these issues will exist.

Despite these challenges, it would be a dangerous strategy for any of the many threatened players in these markets to hang on to this “quality” rationalization for very long. First, Google’s products will get better over time. The sheer volume of the Android phones in the market will give them new data feeds to complement their own mapping effort. Also, they can create UGC hooks for users to embellish their own maps (like in Google Earth), offering themselves further differentiation. With regard to Android, version 3 will be better than version 2 will be better than version 1. Microsoft knows this game well.

Another perhaps even more important factor is that when a product is completely free, consumer expectations are low and consumer patience is high. Customers seem to really like free as a price point. I suspect they will love “less than free.”

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