On January 5, Google launched the Nexus One — the company’s new “superphone” — with a good deal of fanfare. At a press event, Google executives showed off the sleek device, based on the search firm’s own Android operating system with integrated services such as Google Earth, an online map and satellite image tool. Google’s software, combined with a speedy processor, represent a new category of phones “as powerful as your laptop computer of three to four years ago,” said Andy Rubin, Google’s vice president of engineering, in a statement. The phone also includes voice recognition technology for speaking text messages and emails, and touts a 3-D interface, among other features that had the tech world buzzing before the launch event.

Although the launch itself was quickly overshadowed by the online giant’s surprise showdown with China over censorship, the company’s attempt to rewrite the rules of the wireless industry has not gone unnoticed. Google unveiled its own online store to sell the phone independently from wireless service providers that operate as device gatekeepers under the traditional sales model. The goal: Break down distribution barriers and sell the Nexus One directly to consumers. Through Google’s web store, consumers can buy the Nexus One unlocked — separate from carrier service — for $529. For $179, the Nexus One can be purchased with a two-year contract from T-Mobile. Google announced it would offer more devices through its web store in the future.

The honeymoon didn’t last long, however. Google quickly encountered a deluge of customer service complaints about everything from wireless network coverage, buggy touchscreens that wouldn’t allow customers to type, batteries that didn’t hold a charge and high fees associated with returns. These problems were compounded by the fact that customers could only communicate with the company through online forums and email — not live customer service agents.

“When a company is completely virtual and then decides to sell physical goods directly, it’s a different [set of challenges],”says Sergei Netessine, a Wharton professor of operations and information management. “It’s certainly an attractive thing to sell a product yourself without intermediaries, but the customer inevitably comes back to you.”

Yet while Netessine and other experts acknowledge that Google’s Nexus One got off to a somewhat rocky start, the company could still be successful in the long run, they say. The bigger question is whether Google can alter the economics of an industry where the wireless carrier dictates the selection of devices consumers can buy — and whether consumers will be willing to pay a premium to shop for devices that are free from carrier constraints.  

Removing the Gatekeepers

“Is [the Nexus One] going to be the product that opens up the mobile space?” asks Kendall Whitehouse, director of new media at Wharton. “Google wants to release the grip that carriers have on devices and [bring us to] a world where you pick handsets and carriers without a contract.” Typically, wireless phone customers in the U.S. buy a device tethered to a two-year contract through “gatekeeper” carriers such as Verizon Wireless, AT&T, Sprint and T-Mobile. In many other countries, customers buy phones separate from the carrier.

Google also wanted more control over the customer experience, so the company set out to sell its own device and tightly integrate the hardware and software. HTC, a prominent mobile device company based in Taiwan, manufactured the Nexus One based on Google’s specifications. Formed in 1997, the company is known for innovative handset designs and is one of the early adopters of Google’s Android operating system. The product is viewed as a collaborative effort, and each company has a logo on the back of the Nexus One.

For now, however, the Nexus One primarily works with T-Mobile’s network in the U.S. Verizon Wireless is expected to support the Nexus One in the weeks ahead. What’s unclear is whether Google’s effort will truly open up the mobile market, enabling the Nexus One to compete with the top contender in the smartphone category — Apple’s iPhone. Will Google’s model mean that consumers will focus more on the device itself, instead of viewing it as part of a package with a service provider? And will they pay a premium — say, $500 for a phone compared to $199 — for a handset free from carrier constraints?

Gerald Faulhaber, a Wharton professor of business and public policy, says it’s unlikely Google can convince consumers to give up subsidized phones. “Subsidies are attractive to a lot of people,” he notes. Wharton marketing professor Peter Fader agrees that consumers will be slow to change their approach to purchasing handsets. “Yes, consumers should have more variety and choose whether they want to be locked into a contract, but the vast majority of people don’t care. I give Google credit for going against the grain, but what it’s doing just isn’t [likely to make] much of a change.”

David Hsu, a professor of management at Wharton, argues that Google missed a big opportunity to alter the mobile landscape. The company’s approach — selling an unlocked phone so consumers can buy it without a carrier contract — has also been taken by device makers such as Nokia and Palm, he points out. According to Hsu, Google’s real opportunity would have been to take a loss on the Nexus One and sell it at a cutthroat price to gain market share for its Android platform.

Google needs more consumers on its Android platform to drive more usage of the search giant’s services — including Google Maps, its Google Voice service that aggregates multiple phone numbers into one application, and YouTube — and consequently more views for the ads that go with them, Hsu says. “The company’s model depends on getting people to use the device. Google should have massively subsidized the phone and sold it for $100, unlocked. It’s not like Google has a cash problem.”

Some have speculated that Google might eventually give away phones. At Google’s press event, one reporter asked, “Where’s my ad-sponsored phone?” Whitehouse notes that although we’re still a long way from that point, it’s intriguing to consider how low Google would go to reduce the price in an effort to gain market share.

‘One Throat to Choke’

Google’s new device garnered a lot of industry buzz ahead of its early January introduction, making it hard for the Nexus One to live up to the hype. However, customers who were dissatisfied with the phone’s performance faced an unusually confusing retail model. For instance, Google’s help page instructs customers to email the company for questions about orders, charges, returns and their accounts. The company also instructs customers who have hardware, return and repair issues to contact HTC, which includes phone numbers on its own support page. Service questions are directed to T-Mobile, which features a helpline prominently on its help page.

Under the subsidized handset model, customers primarily deal with the carrier, who coordinates the resolution of problems through live representatives. But in the case of Nexus One, if a customer was unsure of the nature of his problem, he could be bounced between three parties.

Faulhaber says that Nexus One customers had a problem finding “one throat to choke” if they had a problem. “What if the phone stops working — who are you going to call?” he asks. “Usually, it’s the carrier that takes care of everything. Anybody can buy their own cable set-top box, but there’s a reason most people just take what the cable company gives them: Service.”

Meanwhile, some customers’ hackles were also up over the Nexus One’s “equipment recovery” fee. Google charges consumers $350 if they return the Nexus One within the first 120 days of carrier service. The fee is in addition to the early termination fee a customer would pay his carrier. According to Google, the equipment recovery fee”is not a penalty but is for liquidated damages Google will incur as a result of such cancellation.”

According to Wharton legal studies and business ethics professor Andrea Matwyshyn, Google’s failure to provide good customer service could hurt the goodwill the company has built up with customers over the years. “Perhaps Google hasn’t thought through the possible negative goodwill impact of engaging in direct sales of handsets,” she says. “I’m surprised they are entering the business this way.”

Hsu adds that retail logistics are outside of Google’s core competency. “Apple sweats the details, but Google doesn’t have those multiple points of contact with consumers. It appears that Google has underestimated the retail, logistics and customer service involved” in such an operation.

According to Netessine, Google is making many of the same mistakes made in the 1990s by early Internet retailers, many of whom tried to do all support via email. However, that approach rarely works, he notes. Customers want phone support. “You have to think carefully about putting real customer support in place and the costs associated with it. If you don’t, you’re better off selling through an intermediary.” It’s too early to determine whether Google will make a big investment in selling phones direct, but Netessine notes that if the company is serious, it will have to spend money on things like call centers and support reps — especially if it offers more Google-branded devices in the future.

Ads and Android

Experts at Wharton say there are multiple reasons for Google’s willingness to strike out in new territory like direct sales of handsets, risking the ire of consumers. Top among them: to gain more traction for Android. “Overall, Google had to be a little dissatisfied with the pace of the uptake and innovation around Android,” Hsu says. Indeed, in a statement, Google said that the Nexus One is designed to show what Android can do if the search giant is in charge of integrating its software, web services and hardware.

For now, the mobile market for ads, software and services is a land grab. “Everybody knows smartphones are going to be the next big platform,” says Whitehouse. “[Mobile devices] will be where people spend most of their time online in the future.”

Faulhaber agrees. “Google recognizes that the wireless market is the next Internet. The standard model of a PC accessing the Internet is a mature market. Google has to position itself for the future. It doesn’t want to be Microsoft, which is a PC-based company.” Overall, Faulhaber says Google has navigated the mobile industry well in its quest. Its Android platform is now powering a wide-range of devices, and Verizon, T-Mobile, Sprint and AT&T have Android-powered smartphones, or plans to introduce them in 2010. In addition, while Google’s catalog of 18,000 applications for Android is smaller than Apple’s collection of more than 100,000 apps, it is solidly in second place.

As with all things Google, the company’s ultimate strategy with mobile devices revolves around advertising, data and referring consumers to businesses, says Eric Clemons, an operations and information management professor at Wharton, who argues that the search giant really sells customer access. “Google reads my texts, and it knows that I am hungry. Google knows where I am. It knows that my friend, with whom I am swapping texts, likes Thai food. Voilà, a text appears from Google offering me a discount on a Thai restaurant quite close to where I am.”

The catch? To achieve that integration, Google needs to control multiple parts of the mobile food chain and put those parts together seamlessly. “It is about [having] all the Google pieces work together,” says Clemons. “There will be one-click access to Google search, YouTube, Picasa, etc. There may not be similarly easy access to competitors’ offerings.”

In addition, Google needs a mobile hit to prevent Apple from gaining an advantage in mobile advertising. Google recently announced plans to acquire mobile advertising firm AdMob for $750 million. Apple countered with the acquisition of Quattro Wireless, another mobile ad specialist. Apple didn’t disclose what it paid for Quattro Wireless, but reports price the deal as high as $275 million.

Experts at Wharton say they expect to see Google and Apple experimenting with mobile advertising formats. “Mobile advertising will have to be creative,” says Fader. “It won’t be just banner ads. The other extreme — which is having your phone shout at you as you walk by a Starbucks — won’t work, either. What will work is a new, clever approach.”

Google: Friend or Foe?

How Google’s relationship with wireless carriers plays out remains to be seen. Some experts expect that Google will push a vision in which carriers become so-called “dumb pipes” — where all the value-added services are delivered via software and web services, while carriers become a mere conduit for wireless access.

That said, the two parties still need each other. “Google and the carriers have a complicated relationship,” says Whitehouse. For instance, Google has argued that some wireless spectrum should be opened up for free use. However, carriers have spent billions of dollars to acquire the spectrum they already have. “Google is a strong partner with an attractive platform that looks good to carriers, but you have to wonder how this works out longer term,” Whitehouse adds. However, he doesn’t see the relationship between carriers and Google as a zero-sum game. “Carriers will still get revenues from subscription fees and a slice of applications and advertising revenues. It’s not ‘winner takes all’ — but carriers will need to keep a close eye on Google.”

According to Faulhaber, Google and wireless carriers will develop two tiers in their relationship. On the product front, the two parties will cooperate. “Everyone needs to do business with Google, so it’s a friend,” he says. However, “in the regulatory environment, Google is not a friend to carriers. Google wants net neutrality, dumb pipes and shared spectrum. For carriers, Google [needs to be] viewed dangerously in Washington.”

Matwyshyn says it’s good that Google has a complicated relationship with carriers, so it can innovate and push the industry to open up more. Ultimately, she notes, “we’ll see what the market says, but Google’s moves can provide consumers with more choice.”