The smartphone battle has now moved from hardware to services

October 1, 2012, 6:17 PM UTC

By Olof Schybergson, contributor

FORTUNE — Five years ago, when Apple came out with the first iPhone, the device experience was far ahead of the competition, and Apple ended up completely disrupting the Telecom industry. Back then, Steve Jobs made the famous remark that with the iPhone, Apple was five years ahead of the competition. And now, five years later, the iPhone 5 is battling it out with increasingly strong competition. And that smartphone battle is now about services more than it is about hardware.

Hardware as Trojan horses for better services

When you read the reviews for the recently launched devices, much of the hardware commentary focuses on the aspects that make the service experiences on the devices better. Fast 4G network connectivity speed is all about faster data to power service experiences. A bigger and brighter screen allows you to see more content and do more things with the services that you use on your device. Better batteries of course allow you to use services for longer without recharging, and faster device processors allow service designers to push the boundaries of their user experience on the device. Almost none of the things that people care deeply about are purely about hardware anymore. The “lightning port” on the new iPhone is a notable exception – many people reacted negatively, and part of the reason is that it’s merely a hardware change that didn’t bring new service value.

Apple’s strategic service focus

It’s well known that Apple makes virtually all its money selling devices with high margins, and clearly Apple are very good at hardware design. But the biggest and most sustainable competitive advantage that Apple has over others is the iOS services ecosystem.

When you analyze the iPhone 5, it’s also clear that Apple knows the crucial role of services. There are no big breakthroughs on the hardware or user interface front. Arguably, this is not because Apple thinks its UI and hardware is perfect, but because Apple has deemed it more important to double down on other areas of the iPhone – namely services.

Last year’s big iOS innovation was Siri. It’s telling that Siri is the only software that the perfectionists at Apple have released in beta mode – it speaks volumes about the strategic role and importance of the voice-activated virtual assistant service. The iOS 6 version of Siri will be much improved. It will be faster, more responsive, and more flexible. This is a service that Apple considers vital for its future.

With the iPhone 5, Apple went one step further still. They booted the wildly popular Google Maps off iOS and replaced it with their own mapping service. With Siri, Apple had brought a slightly flaky but genuinely innovative new service to market. But with maps, they replaced a loved and popular Google service with their own inferior solution. The reactions have been very harsh. How come Apple downgraded maps on their devices? Surely they knew it wasn’t better than Google Maps? They did it simply because control over a maps service is a necessity for them long-term. They risk alienating loyal users in order to build their own service platform – instead of relying on others. This shows how important services are to the future of Apple and to iOS.

The service assets of Nokia and Microsoft

Microsoft has numerous powerful service assets – from cloud services and Skype to Xbox and Outlook. But arguably, the most powerful asset they have going forward is the range of service developers that will create solutions for Windows 8. This will offer a massive boost to the Windows ecosystem, and will benefit Windows Phone 8 manufacturers.

After an ill-fated push into music with Ovi Music some years ago, Nokia are now re-entering the music service business with the streaming Nokia Music service. Nokia’s acquisition of mapping platform Navteq five years ago was widely criticized for the high price tag. However, today Nokia’s mapping platform powers 4 of 5 in-car navigation systems globally, Nokia will power the maps in Amazon’s latest Kindle Fire devices, and Nokia Maps are regularly receiving excellent reviews when compared to other mapping solutions, including Google Maps. Nokia Maps is clearly one of the company’s crown jewels. The combined service assets of Microsoft and Nokia are impressive and mutually beneficial.

In comparison to both Apple and Nokia, the recent smartphone launches from Motorola and HTC feel unsatisfying. While their hardware is certainly good enough to compete, the lack of smart service solutions leaves the devices flat when compared to the might of Apple’s ecosystem and the magic of their virtual assistant Siri, and also when compared to the photography innovation or the mapping excellence showcased by Nokia.

Services are Samsung’s Achilles Heel

Samsung has long been a fast follower. But they currently sell more smartphones than anyone else, including Apple. Their Android-based smartphones have sold in the millions, and they are currently the only smartphone manufacturer other than Apple that makes significant profits. One of the reasons that they’re so successful is that they spend vastly more money than anybody else on marketing its smartphones.

But Android is Google’s baby, and Samsung have not traditionally been an innovator with services. Samsung has not brought many own service experiences to their smartphones. This lack of service expertise is likely to become a significant challenge for Samsung over the next phase of the smartphone battle. While Samsung sells lots of devices, their customers are unlikely to be very loyal to them. When the next shiny experience from someone else appears – and there’s a growing range – they might well try out another manufacturer’s device.

The U.S. vs. China

All of the most important smartphone operating systems are now creations that originate from the West Coast of the U.S.– iOS, Android, and Windows Phone. This is because the U.S. tends to be better at software than other countries, and also because the creators of these operating systems – Apple, Google, and Microsoft – are all focusing on either developing or integrating with useful and desirable digital services.

If hardware would be the most important factor in the race for gadget supremacy, China would be the king of gadgets. However, the gadgets that are capturing people’s imagination and are changing the world tend to be brilliant service and software solutions, wrapped in desirable hardware. China hasn’t yet produced any brands that in the West stand for service and software excellence. The focus on software and services gives the U.S. a head start over China.

Services to the rescue

As PayPal’s Carey Kolaja observed, the technology “NFC” is often mistakenly confused with mobile wallets. Carey’s point is that while digital wallets will become an indispensable part of consumers’ everyday lives, and one that will save them time and money, consumers don’t care which underlying technology is used to enable the wallet. As she put it, “The iPhone 5 doesn’t have NFC – so what?”

It will become increasingly hard for device manufacturers to compete and differentiate on the basis of technical or hardware features alone. Instead of being unique selling points, the technical features and hardware specs – Megapixels, Gigahertz, RAM, screen size, and network connectivity – are relegated to hygiene factors. If you have too little, it’s too bad. But having the most is not necessarily helping you sell more devices anymore.

What people truly care about is fast and reliable access to useful, engaging and innovative services that deliver real value.

As the world’s leading companies are increasingly going mobile first, and as mobile device sales rapidly shift from feature phones to smartphones, it also impacts society. The digital divide will start to shrink, as digital services and information is increasingly reaching everyone – not through computers, but through affordable smartphones.

It’s what’s on the inside that counts

Of course hardware still matters – especially when the device purchase decision is made. People naturally respond to physical objects and experiences. The weight, size, and color of devices are clear considerations when people decide which gadget to buy. Smartphone screens are like magnets for people’s eyes – the bigger and brighter, the stronger the magnetism. Smartphone technology can still amaze, as evidenced by the fact that Nokia’s 808 – equipped with a monster 41Mp camera – won the “Best of Show” award at Mobile World Congress this year. In the fast-emerging wearables space, taste is meeting technology. Hardware like Nike’s FuelBand and Jawbone’s UP are smart fashion objects, and looks clearly matter.

But smartphones have become so much more than simple utilities for us. They connect us to our loved ones, they allow us to access important information at any time, and increasingly they help guide us through all aspects of life. They have graduated from tools to life companions. And just like in human relationships, while appearances matter, it’s what’s on the inside that counts. The devices that offer the best access to well-designed living services that evolve with us will win the mobile race that’s only just begun.

Olof (@olof_s) co-founded Fjord in 2001, and has since led the company to become one of the world’s most successful service design consultancies working with clients including the BBC, Citibank, ESPN, Flickr, Foursquare, Harvard Medical School, Nokia, and Qualcomm, among others. Olof has years of experience collaborating with major brands to design breakthrough experiences that make complex systems simple and elegant. A frequent speaker at global conferences and events, recent appearances include Fortune 2012 Brainstorm Tech, GigaOm Mobilize, and Rutberg Future: Mobile.