I had an off-the-cuff thought yesterday and tweeted it:
Seems far fetched right? Perhaps not. Hear me out on this one... Three years ago, Schmidt made it clear and in no uncertain terms he believes phones should become free as ad impressions per user out-earn two-year carrier contract subsidies plus mobile device hardware costs. Widely considered industry blasphemy back then, I'll admit I didn't fully understand how an ad subsidized free device might be possible. I've come to learn it's feasible through experience... A year after Schmidt made his thoughts public, I started working for a handset manufacturer where I was responsible for inking deals with vendors in the supply chain.
While building phones, I learned there are many components that go into a production and distribution, and each have costs in a complex array of supply chain economics. Our total bill of materials was about $60. Beyond the core BOM, we also budgeted for ancillary packaging, shipping, distribution, logistics, and GSM patent licensing costs, plus one-off FCC certification, tooling and assembly line costs - the later two of which were charged-for by our Chinese OEM, Nollec. Nearly all of our silicon and component costs were available at discounted prices, primarily because Nollec had previously used our selected piece parts in designs for other manufacturers and preexisting supply chain contracts were in place - we simply inherited what was already available in the market and used two-year old technology that was less expensive. After all costs, our unlocked street price generated a 45% gross margin for the business, which made it profitable.
Anyway, the mobile industry supply chain I worked in (the one that still exists today) is complex - as is its money flow. If Google were to pull-off offering a free phone (or an easily obtainable inexpensive one), I suspect they would have to front at least some of the initial supply chain and manufacturing costs themselves - initial up-front costs run too much red for HTC and their technology suppliers to bear in suspended after market return. That said, I do not doubt that ad revenues generated per user over time could indeed cover all embedded and production costs needed to maintain existing profit margins for supply chain vendors and OEMs.
Pretend for a moment that the Nexus One costs $300 to produce. This cost may seem high, but with all the cutting edge tech inside it, this may be a fair estimate. HTC, Qualcomm, and everyone else needs to earn what they earn now from a $300 BOM. Could Google generate the $300 over the life of the device from businesses advertising through them? I think so, but in order for it to be profitable for Google, they would need an additional margin beyond the BOM costs. Is that possible? Sure. I can see a device like the Nexus One generating a couple thousand dollars per user from businesses seeking third screen reach through highly contextual and personalized mediums. So, free could be possible.
Others speculate if a free or even inexpensive Nexus One is launched, it will leave little reason for other handset OEMs to follow or care about Android if hardware profits are eliminated.
I'm not so sure. Profits aren't eliminated with this model, they just have a different point of origin and the money flows differently. Assuming the existing supply chain earns what they've grown comfortable with, why should anyone care if payment originates from businesses who pay Google to advertise versus payment originating from consumers, through the carrier, onto handset manufacturer's and subsequently onto the technology supply chains. From this perspective, a free Nexus One seems possible, and I wouldn't be a bit surprised if it happens. It's disruptive as hell, and "as long as you're on the side of the consumer, you'll be fine", right? :-)