Microsoft Build – Bots and bobs.

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Steady evolution but existing issues still need fixing. 

  • Microsoft launched a series of evolutionary upgrades to Windows 10 and the devices that run it, at its /build// developer conference in San Francisco.
  • This is the key conference that gives visibility on where Microsoft intends to take its ecosystem over the next few years.
  • While there were some interesting developments, some of the short comings of the existing ecosystem were not addressed.
  • The top spots were:
  • Conversations as a platform.
    • This is all about instilling a much greater level of intelligence into every device that user has including iOS and Android.
    • The initial focus is around intelligent bots that can allow companies offering goods and services to interact with their customers much more easily.
    • The fact that bots are very early stage is highlighted by Microsoft’s Tay AI chat bot on Twitter that this week became a racist, sexist bigot as it was not smart enough to realise that this was inappropriate.
    • The failure of this experiment is why things are starting off from a very simple premise.
    • Microsoft has launched a framework for creating simple bots (.bot) that can take orders and recognise a degree of natural language and escalate to a human when it gets stuck.
  • Cortana
    • As part of this initiative Cortana is becoming much more deeply integrated into Windows 10 and developers can also integrate its intelligence into the apps that they build.
    • This will work on Android right away but typically it will not work for iOS just yet, although Microsoft promised that it is coming.
    • These are all the right places to take Cortana, but I still think that its fundamental intelligence needs a lot of work as it still significantly underperforms Google Now when tested.
    • This is evident in the fact that usage of Cortana remains very low.
    • There are 270m installations of Windows 10, each of which is Cortana enabled, not to mention Cortana’s presence on non-Windows devices.
    • However, it is only answering 1m questions per day meaning that only 0.37% of users use it daily.
    • In the best case scenario this translates into 11% of users using it once per month but I suspect that in reality this is more like 3-5%.
    • To get this number up, Cortana must become much smarter although the deeper integration launched here will help.
  • Windows 10 Anniversary update.
    • The uptake of Windows 10 is coming along very nicely with 270m devices using the code with an encouraging trajectory of take up.
    • Against this backdrop, Microsoft will enhance certain aspects of the experience to make it more intuitive and easy to use:
      • First. The Windows Hello authentication used for logon will now be available to be embedded into apps and websites visited with the edge browser.
      • Second. The use case for Ink will be enhanced such that the pen can be used to make smart annotations in multiple programs.
      • The aim here is to encourage the 72% of users who still use pen and paper to switch some of that usage to digital.
      • Third. Xbox One games will run on all Windows 10 devices and the device can now be used as a development environment to make development more straight forward.
      • Fourth. Visual Studio will be usable to develop apps for all platform including Android and iOS.
      • This went hand in hand with improving on the code converters making porting across these platforms more straight forward.
  • Cross device.
    • The story of services and functionality working across all platforms was hammered home at every opportunity.
    • This includes not just the whole range of Windows 10 devices, but also iOS and Android devices as well.
    • The demonstrations of services jumping from one device to another and one platform to another were seamless and convincing.
    • This reinforces my view that when it comes to cross device and platform, Microsoft has developed an edge over its competitors that needs to be aggressively marketed to users.
  • While these updates represent a solid evolution of the offering, there was no real mention of addressing some of the real problems that the Windows ecosystem is still grappling with.
  • This includes the problem that all of the data that Microsoft collects from its different services is not pooled together to provide a better and more enhanced experience for the user.
  • Furthermore, integration between the different services also remains very weak and it remains to be seen how well these new updates address these problems.
  • The net result is a good development path for the ecosystem, but the existing problems have to be fixed before the user experience will really shine and appeal to users.
  • Microsoft is still quite attractive even it completely messes up its ecosystem strategy, making it a very low risk investment with plenty of upside, should it get it right.

Tidal – Exclusively dependent.

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Tidal’s only real hope lies in exclusives.  

  • Tidal has posted better than expected metrics on the 1st anniversary of its relaunch but it remains sub-scale with only one real hope of longevity.
  • Tidal now claims to have 3m paying subscribers of which 45% (1.35m) are on its high quality (lossless) tariff of $19.99 per month.
  • These days every man and his dog has 40m tracks and a search box meaning that anyone looking to make it in this space has to offer something different.
  • Tidal’s library is pretty much as good as anyone else’s but its potential for differentiation lies in its high quality offering and the potential for exclusives.
  • Spotify does this by offering machine learning and data analysis to make high quality recommendations to users as well as innovative add-on features like Spotify Running and Spotify Connect.
  • Apple manages to differentiate by being Apple but I continue to think that the real plum that Apple is going after remains radio (see here).
  • YouTube differentiates by being an encyclopaedia of almost anything the user can think of with video in some instances.
  • I continue to believe that the key to the streaming business is scale.
  • This is because anyone starting out in this business will find that the gross margins are extremely challenging when one has to pay away 70%+ of revenues to the labels.
  • When other costs have been removed, gross margins can end up at 20% or lower without difficulty.
  • This makes breaking even very challenging without achieving substantial scale first.
  • Obtaining huge scale shifts the balance of power as the content owners will begin to need the streaming service more than the streaming service needs them.
  • It is then that negotiations for better gross margin can begin.
  • Tidal is holding itself out to the market as a service that offers high quality streams but there is only a limited number of music buffs that care enough to pay the premium.
  • Consequently, Tidal is unlikely to obtain scale using quality as a differentiator.
  • The other option is music exclusives and here its unusual ownership structure has been of some help.
  • Tidal owned by a collection of artists and it is aiming to expand the number which has now reached 20 from 16 a year ago.
  • The idea here is that if these artists keep their music exclusive to Tidal, then it will add another string to its bow for differentiating itself.
  • However this has two problems.
    • First. Most of the artists do not own the rights to their music meaning that their catalogues invariably show up on Spotify and Apple Music regardless.
    • Second. Tidal is not big enough for the artists to make a decent return by staying true to an exclusive.
    • The most recent example of this is Kanye West who originally claimed that his most recent Life of Pablo album would remain exclusive to Tidal, but has released the single from the album on both Apple Music and Spotify.
    • I suspect that the rest of the album will soon follow.
  • Consequently, I remain concerned for Tidal’s long-term future and think it very unlikely that it will ever be in a position to put pressure on its rivals.
  • The music buff segment is unlikely to be big enough to earn a decent return and its owners appear likely to break ranks in order to earn a better return elsewhere.
  • Tidal remains no threat to Spotify, Apple Music, YouTube or even Deezer.

Facebook – The beaten track

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Facebook’s plans for Messenger follow its Asian rivals.

  • Facebook is preparing to do much more with Messenger as the Asian examples are showing that much more can be done with these platforms beyond instant messaging.
  • Digging by The Information reveals commands embedded in Messenger’s code that will enable a whole host of added functionality.
    • First. There is clearly the potential for Messenger to be used as a payment mechanism.
    • This would include the ability to pay for goods and services in store as well as directly in the app.
    • This is all well and good but the real secret to payments is not the app but the backend and fulfilment and how this will work is unclear.
    • Second. There are signs of functions that will beef up the capability of companies to talk to their clients via messenger and to use messenger as a customer service channel.
    • Chat has already been shown in a number of studies to be a very effective and efficient way of offering customer service.
    • Third. Facebook appears to be planning on adding suggested businesses and services to Messenger that I presume will be based on the user’s activity within Facebook.
    • Fourth. Functionality is appearing that would allow Messenger to add events to the calendar which is clearly related to Facebook M, Facebook’s digital assistant.
  • Although this is virgin territory for Facebook, its Asian rivals Wechat / QQ, LINE, KakaoTalk and Alibaba have been on this path for quite some time.
  • Furthermore, they have has significant success with mobile being used much more than fixed in many use cases such as shopping online.
  • In particular LINE and KakaoTalk have been very successful in monetising their instant messaging platforms through the sale of games and stickers.
  • Both are now moving more broadly to offer content, live broadcast and advertising in a bid to continue growing their revenues.
  • These strategies are working well in Asia, and especially in China, but how well they will work in the West remains to be seen.
  • This is because there are significant cultural, regulatory, historical and practical differences between Asian and Western markets that mean that the outcome could be very different.
  • The example of NTTDoCoMo’s first ecosystem, i-mode, which was very successful in Japan but was a complete failure elsewhere shows just how difficult this can be.
  • This leads me to believe that while Facebook is on the right lines when it comes to expanding Messenger’s functionality, it will have to do it differently to account for the market differences.
  • I see Facebook expanding into media consumption, shopping, gaming and search which will give it over 80% coverage of the Digital Life pie and market leadership.
  • However, it is one thing to cover the pie and quite another to monetise it as the example of Google + shows (see here).
  • Assuming that Facebook gets it right, it is on the way to create a thriving ecosystem that RFM estimates could allow it to double its revenues over the next 5 years or so.
  • Consequently, Facebook shares look very attractive in the long-term but I would not be building a position just yet (see here).
  • In the meantime, I am looking at Samsung, Microsoft, Google or Apple as safer places until the dust settles.

Wearables – All pain, little gain.

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Wearables are already a commodity despite unit growth.

  • Pebble is the latest wearables company to show signs of stress as it has decided to lay off 25% of its work force.
  • This comes hot on the heels of Apple cutting $50 (14%) off the entry price of the Apple Watch, a poor reception for Fitbit’s latest product and a slew of M&A and restructurings at the end of last year.
  • The problem is not market growth, but the fact that Apple Watch has taken the premium segment has left the majority of the rest of the market priced well below $100.
  • Top of this list is Xiaomi which prices its Mi Band Pulse at just $13 meaning that anyone who wishes to price their product at a premium has to offer a lot more than just fitness tracking.
  • This is where I think Pebble (and others) have been caught in the middle and why it has become much harder to make any real money despite the market growing nicely.
  • In 2015 the wearables market grew 171% to 78.1m units (IDC) driven mostly by Apple and Xiaomi at the two opposite ends of the market.
  • I think that the reason why there is so little differentiation remains that no one has really figured out how to make a wearable product a must have.
  • Even Apple, which has a legendary ability to come up with compelling use cases, has struggled and the main question asked by potential users is: “Why would I buy it?” rather than: “How much is it?”
  • Fitness tracking is already a commodity and one with which many users rapidly tire.
  • Health tracking is also in its infancy as the sensors are still not close to being good enough to provide safe and secure health monitoring (see here).
  • Outside of that, wearables are little more than remote controls for a smartphone providing no reason for mass market adoption.
  • I suspect that this year will see growth in unit volumes but the value of the market will be much more challenged with brutal price erosion.
  • Of all the wearable players, Apple is likely fare by far the best as it has a very strong ecosystem which is critical to ensure differentiation.
  • Even Fitbit, which currently leads this market, is likely to struggle as it does not have the scale nor the experience outside of fitness tracking to put together a user experience compelling enough to keep its gross margins where they are.
  • Hence I think that 2016 will be very difficult for wearables in general as the ravages of commoditisation bite despite unit growth.
  • Apple is the only company with exposure to this market that looks even remotely safe.

Technology industry – Broken rhythm

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The breaking of Moore’s Law will make software even more important.

  • Intel’s significant change in the rhythm of its die shrinks is the biggest indication yet that Moore’s Law is finally beginning to break down.
  • Since before almost any of us can remember, the technology industry has been governed by the concept of Moore’s Law.
  • This states that the number of transistors inside an integrated circuit will double every two years or so.
  • This has had massive repercussions because in practice it means that computing power has doubled every 2 years while the cost has stayed the same.
  • It is this law that has underpinned the breakneck pace of innovation in the hardware industry and has allowed many companies to compete by producing cutting edge hardware.
  • In its latest 10K filing, Intel has stated that its Tick (process) – Tock (architecture) rhythm before moving to another geometry will now have an extra stage (optimisation) added making three stages rather than two.
  • In practice this means that Intel will spend longer on the 14nm and below geometries with three product generations per geometry rather than two.
  • I suspect that it has done this for reasons:
    • First. Each geometry migration is meaningfully more difficult than the last, requiring more time to get yields to the point where they are commercially viable.
    • Second. The cost of each migration is also increasing substantially necessitating greater revenues in order to make a return on the investment made.
    • Third. The industry is rapidly approaching a time where smartphones and tablets have enough computing power meaning that technical specifications will no longer carry a high price premium.
  • For Intel, this represents a huge risk.
  • This is because it has always competed on its technical prowess in being able to make transistors so small that its devices could always outperform those of the competition.
  • By lengthening the amount of time it spends on a particular geometry, Intel will give the competition more time to catch up and offer an equivalent product at a much lower price.
  • However, these days how the silicon is implemented can be more important when it comes to performance than the exact specifications of the silicon itself.
  • Consequently, it looks like Intel is intending to compete along these lines more in the future rather than marching as quickly as it can to smaller and smaller geometries.
  • For the rest of the technology industry it is an indication that the speed of commoditisation as going to accelerate even more than it has done already.
  • As smartphones and tablets become powerful enough to do almost anything that the user is likely to expect, the value attributed to adding even more power on top will vanish.
  • This will mean that differentiation will move even more into the functionality and into the software that sits on top of the hardware.
  • This will be true for all devices not just smartphones and tablets but TVs, home appliances, consoles, wearables and so on as they become relevant to the Digital Life and Digital Work ecosystems.
  • The ecosystem is the glue that holds all of a user’s Digital Life together in a seamless, easy to use and fun way.
  • It is here where differentiation will occur and where the winners of the technology industry will earn their profits.
  • It comes as no surprise to me that the ecosystem companies: Apple, Microsoft, Google, Baidu, Alibaba, Tencent, Amazon and Facebook have a greater market capitalisation than almost all of the others combined.
  • There are of course exceptions to this which tend to be companies that have developed a sustainable differentiation in hardware.
  • Examples of this are ARM which owns the core processor technology for mobile devices, Qualcomm which has an edge in cutting edge cellular radio and MediaTek through its low cost production and media expertise.
  • For everyone else stuck in the middle, the choices are to either eke out a commodity existence (like Samsung does very well) or try and differentiate in the ecosystem.
  • It is the companies that make this bold choice that are likely to outperform the most but at the same time they also carry the greatest risk.

Apple – Housekeeping

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A housekeeping event that refreshed the older end of its offering.

  • Apple released new products and software that inched the evolution if the ecosystem forward, but there was nothing that will kill the impact of the end of the massive iPhone 6 upgrade cycle.

iPhone SE

  • This is best described as an iPhone 6 in the body of the iPhone 5s at a cheaper price.
  • The device will be available for $399 for the 16GB version and $499 for the 64GB version.
  • Apple sold 30m of its older 4” devices over the last 12 months and there are a significant number of users still using these products.
  • Furthermore, around a third of these sales (two thirds in China) were to first time iPhone users and it is to this segment that Apple is targeting this product.
  • The iPhone SE is essentially Apple’s second attempt at cracking the mid-range but I think that the price has not come down nearly enough (iPhone 5c was $450 at launch) to make a real impact on the mid-range of the market.
  • Consequently, this is a good upgrade for the old iPhone segment but it is unlikely to trigger a market share gain or a sudden increase in size of its ecosystem.

iPad Pro 9.7”

  • This is an exact replica of its big brother except that it has a 9.7” screen and consequently comes at a slightly lower price.
  • This device now starts at $599 for the 32GB and goes up to $899 for a 256GB version.
  • Apple is targeting the 600m PCs that are in use today that are over 5 years old and in that regard the new screen size is a good idea.
  • This is because the critical application for a PC is the productivity suite Microsoft Office.
  • iOS and Android have touch optimised versions of the Office programs which are good for reviewing documents and basic editing but quickly reach their limits when in depth content creation is required.
  • With a screen size below 10”, these apps will be free to download and use (within certain limits) which will be a big draw to anyone considering the switch.
  • However I think that Apple will still struggle to attract this segment for two reasons.
    • First. Almost all content creation outside of design is much easier and much more productive with the use of a mouse which iOS still does not support.
    • There is no reason why this could not be added to iOS and it is something that I will be looking for at WWDC in June as a sign that Apple is taking productivity seriously.
    • Second. The iPad Pro is still too expensive at $749 for the 128GB version.
    • The equivalent Surface 3 product from Microsoft with a 10.8” screen, mouse support and capable of running the full version of Office (and every other legacy application written for Windows) is $448 some 40% cheaper.
    • This means that as a laptop or desktop replacement, the iPad Pro is going to fall short as no user that really cares about Office is likely to choose it over the Surface.
    • I continue to believe that the vast majority of the use case for the iPad Pro will remain content consumption as every device I have seen in the wild has been used exclusively for this purpose.
    • This is where this product really excels with its best in class user experience and third party app ecosystem.
  • Hence, I do not see the owners of the 600m old PCs flipping to this device but I do see older iPad users upgrading to this new product in time.

Watch, TV and iOS9.

  • Incremental upgrades were announced to these products with new watch bands, a lower price (indicative of lower than forecast volumes) as well as improved functionality for the TV and a new version of iOS 9.

Take Home Message

  • This was a housekeeping event for Apple where it updated parts of its offering that were a little tired as well as picking up a few loose ends.
  • It was not an event that will have everyone scurrying off to their spreadsheets to increase their estimates.
  • Consequently, the main issue that besets Apple remains its lack of growth.
  • There is very little that Apple can do about this as it is now paying the price for the huge growth that it experienced from the iPhone 6 product cycle.
  • This is why the shares are valued at such a low level despite being a cash generation powerhouse that is second to none.
  • This makes the shares offer extremely good value for anyone that is not concerned with growth as the cash returns are excellent.
  • However, those that are looking for capital appreciation in the short term are likely to get more joy from Samsung, Microsoft or Google.

Network economy – Unicorns and donkeys Pt. IV

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Inability to reach scale is killing the delivery start-ups.

  • The highway of 2016 is being littered on a daily with the crashes of start-ups that have been so focused on obtaining huge network scale that they forgot the basics of economics.
  • Almost exclusively, it is the start-ups that involve pick-ups or drop-offs of an asset that have got into trouble.
  • This is because of the high level of fixed costs that these companies incur as a result of requiring lots of employees or contractors to do the picking-up or dropping off.
  • Both on demand valet parking and food delivery services have been in the spotlight recently with SpoonRocket closing and almost all of the on demand valet industry imploding (Luxe, Zirx, Valet Anywhere) or exiting the on-demand model (Caarbon and Vatler).
  • I think that the single biggest problem that all of these start-ups have faced is that labour is expensive in developed markets.
  • In the start-up phase it is very difficult for these companies to make any money because they do not have enough scale to efficiently use the resources that they have.
  • For example, delivery personnel and car valets have to be paid whether they are out doing deliveries or simply sitting around waiting for a job.
  • Most importantly though, the network effect has not kicked in for anyone and this has caused substantial problems.
  • A food delivery or valet company that is the go-to place can charge higher prices to diners and also demand higher commissions from the restaurants.
  • In order to get to this hallowed position I think that a networked business needs to have 60% market share or be double the size of its next competitor.
  • Even Munchery which is one of the best financed start-ups in this area is not immune as its Chief Customer Experience Officer has just resigned after only 5 months in the job.
  • Although, it would appear that there has been some personality clash, I suspect that he has also been prevented from developing the customer experience due to monetary pressures.
  • Even India, where personnel are much cheaper, has not been immune as there are so many of them all fighting each other that the network economics are unable to emerge.
  • What usually happens in these situations is that several will fall by the wayside and the strongest will buy up the rest and obtain the scale necessary to make the network economics work.
  • This is exactly what Zomato is doing with its strategic investments in Pickingo and Grab, but whether it has the financial clout and execution capability to consolidate the sector remains to be seen.
  • However, I am pretty sure that as a classifieds website for restaurants that has been around since 2008, it understands how critical the network effect is.
  • The end result is that the initial phase of hype and euphoria is properly over and the shake-out has already begun.
  • Only the strongest with the most money are likely to survive and will do so by buying up the competition or waiting for them to wither on their own.
  • For the rest, the unicorn disguises are already slipping revealing the true colours of the donkeys underneath.

Alphabet – Goodbye blue sky

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Money talks, robots walk.

  • It looks like Alphabet has put its robotics venture, Boston Dynamics, up for sale because there is no immediate path to earning a return on the money invested for Alphabet.
  • Boston Dynamics is a robotics company that specialises in robots that are autonomous as far as navigating and adjusting to their immediate environment.
  • This means that they can move around with relative ease but how these robots could generate value for Alphabet shareholders is completely unclear.
  • At the end of the day Alphabet is a data and analytics company whose objective is to categorise and understand every piece of digital information about users and to sell those insights to marketers.
  • Every other piece of hardware that Alphabet makes from thermostats to internet balloons, have the capacity to collect huge amounts of data and thereby generate value to the core business.
  • The robots of Boston Dynamics do not collect data about users.
  • Instead they replace them making a business case around data extremely difficult.
  • Consequently, it seems likely that Boston Dynamics will be more valuable to an owner with a different business model such as Amazon, DHL, UPS, Cainiao (Alibaba logistics) or even the military.
  • Consequently, I suspect that there will be plenty of interest in purchasing this company but I doubt that Alphabet will book a huge return on the sale.
  • This is an encouraging sign of greater fiscal discipline at Alphabet which I think has been lacking for many years.
  • The arrival of Ruth Porat (CFO) from Morgan Stanley has triggered improvements but there is still one big nut to crack.
  • This is the general and administrative expense which is still between 7 to 8% of sales, some 200-300bp above where it should be.
  • I think that a large tech company should be spending a maximum of 5% of sales on GNA and in 2016E, RFM forecasts that Alphabet will waste around $2bn on excessive spending.
  • This is a small improvement compared to the last 2 years but more still needs to be done.
  • With the decision to sell Boston Dynamics being based on the economics of this company rather than blue sky, I have greater hope for progress on fiscal discipline.
  • The immediate outlook for Alphabet looks good as my concerns around its ability to earn a return from Android (see here) are unlikely to impact Alphabet before 2017.
  • Hence I can see Alphabet outperforming Apple in the immediate term, although I would also be considering Microsoft and Samsung as places to look for value.

Cyanogen – Lucky 13

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Cyanogen refreshes the parts other ecosystems don’t reach.

  • Although Cyanogen’s business model remains highly questionable, the evolutions it is making to the user experience show a good understanding of what will drive ecosystems in the long term.
  • With the release of Cyanogen OS 13.0 release 1, Cyanogen’s latest innovations within the user experience are ready to make it onto real devices.
  • The big difference with Cyanogen OS 13.0 is the inclusion of what Cyanogen refers to as Mods which are apps and services that have been deeply integrated into the OS.
  • This allows them to be more aware, more contextual with access to much more data than normal apps.
  • Consequently, Mods can offer the user a deeper and richer experience which I have long believed will be very important factor in the user’s ecosystem decision over the next 3-5 years.
  • In effect Mods are apps that sit on top an application framework which extracts the data that the apps generate and stores it in a common database.
  • This data is then made available to any other app that is also using the application framework.
  • This how Mods can be aware of what is relevant and of interest to the user even when that data has been generated by another function or service.
  • In iOS and regular Android today, every app is an island keeping the data to itself and can only access the data that it generates.
  • This is fine for basic functionality but as ecosystems become more sophisticated and users want more from their devices, it becomes limiting as advanced functionality is not possible without the sharing of data.
  • This is exactly what RFM’s Law of Robotics No. 5: Data Sharing calls for in terms of assessing how well an ecosystem is set up to differentiate in the long term.
  • Cyanogen has already created some Mods to get the ball rolling but the idea is that handset makers and other licensees of the software create their own in order to differentiate their products.
  • Truecaller, Social lock screen, Skype, Cortana and OneNote are all examples of mods that are available from the beginning.
  • The fact that 3 out of 5 of the launch mods are from Microsoft comes as no surprise, as it has long embraced the idea of data sharing by apps.
  • I think that this puts Cyanogen in a good position to improve its appeal to handset makers as this approach is currently unique.
  • Unfortunately, I think that traction in the last 12 months has proved difficult.
  • Its biggest customer Micromax has lost 50% of its share in its home market and Chinese vendors that started with Cyanogen have since moved off and are doing their own thing.
  • This leaves Cyanogen as a great option for many of the smaller niche vendors like Wileyfox and Obi Mobiles but to make money, this company badly needs a large vendor to use it so it can rack-up some meaningful volume.
  • Consequently, I think that Cyanogen’s vision is right but to keep its shareholders happy, it needs to focus on practical strategy and execution.