I’m not sure what it is that makes so many business pundits and investment managers continuously underestimate Apple. I think it boils down to a belief that regardless of whatever success Apple has recently pulled off, Apple’s fate was already sealed years ago when it decided to sell an integrated hardware/software product.
Pray for Apple
Because Microsoft was able to control the market for desktop operating systems and force hardware OEMs to do its bidding, the company became staggeringly successful. It also handily trounced Apple, turning the company that kick-started personal computing into an also-ran. By 1997, Wired Magazine’s June cover story was titled “101 Ways to Save Apple.”
Of course, in 1997 there was plenty of reason to believe that Apple was on its way down the toilet bowl. The hardware/software integration that Apple steadfastly followed was an approach doomed to failure, as the success of Microsoft had shown. Michael Dell declared that if he were running Apple, he’d “shut it down and give the money back to the shareholders.”
Microsoft leveraged an operating system that ran on a common hardware specification, which gave it the power to reap monopoly rents. Dell’s innovative build-to-order distribution system allowed it to grab the lion’s share of the PC hardware market. Meanwhile Apple, with its all-in-one approach, continued to innovate but couldn’t grow its user base.
Eleven years later Microsoft is still the big dog, with a market cap of around $270B. But the Colossus of Redmond is losing dominance. Vista took years to develop and has been roundly panned as an underachiever. Google has built a tremendous lead on the Web. The LAMP stack has thwarted Microsoft’s pursuit of IT dominance.
Even Apple is a serious threat now. The company’s market cap of around $160B is four times that of Dell. Macs are flying off the shelves in greater numbers than ever before. Developer mindshare has shifted radically in Apple’s favor, and Microsoft’s grip on consumer and business customers is weakening.
Reaching Past the Faithful
How did this come to pass? First, Steve Jobs returned to the company he co-founded. At the time, analyst Charles Wolf echoed the prevailing sentiment when he said of Apple, “They have a dramatically loyal installed-base and that’s the one asset they have.” Jobs tore down the confusing and duplicative Mac product structure (remember Centris, Classic, Quadra, and Performa?) and nixed the Newton.
He was able to keep faithful customers happy by trimming the product line while introducing a groundbreaking machine called the iMac that tempted more than a few Windows users. A series of head-turning hardware releases followed, as Jonathan Ive and his design team moved from translucent plastics to titanium to aluminum. Apple’s software underpinnings took a huge leap forward with Mac OS X. The company rolled out the iPod and iTunes, and shipped the iLife application suite with every Mac. Consumers responded, turning the iPod into a runaway success, and making iTunes the first viable legitimate online music store. Apple’s share price slowly moved up, but some analysts still damned Apple with faint praise.
In April of 2004, shortly before APPL began its vertical ascent of the stock charts, Transamerica portfolio manager Chris Bonavico told CNN Money’s Stephen Gandel, “Apple will remain a company that is neat from a product and consumer standpoint but crap from an investor standpoint.” Gandel’s article was essentially a hit piece, painting the iPod and iTunes as side ventures that weren’t doing enough to push Macintosh sales. He also questioned the viability of Apple’s retail stores.
Distribution is the New Black
Gandel inadvertently touched on perhaps the most important aspect of Apple’s stunning success. Design is certainly a huge part of the appeal of Apple’s products. The hardware and software work very well together. The devices are sturdy, well-designed, and aren’t just targeted at 15-30 year old male geeks. Generally speaking, Apple products do what you expect them to, without fuss. Just as importantly, they don’t get in your way. But Gandel didn’t focus on design. Instead he poked holes in Apple’s new distribution framework.
The retail stores he thought were a waste of money, the iPods that didn’t convert enough consumers to Macs, and the iTunes Store that pulled in paltry revenue became the distribution framework that allowed Apple to create a completely new relationship with consumers. Apple lost the War for the Desktop, but they learned many lessons from that defeat.
Pulling the Middleman Out of the Driver’s Seat
I remember the days before the Apple retail stores arrived. While there were a few noteworthy exceptions, as a rule buying a Mac and having it serviced was always something of a roll of the dice. Apple took a lot of heat and fought off a lawsuit from disgruntled retailers when Apple launched the retail stores. But the truth is that many of those retailers were damaging Apple’s relationship with its customers, at a time when the company was being relentlessly pressured by Dell’s direct distribution model. Dell was able to control its relationship with customers far better than Apple, until Apple got serious about managing its retail presence.
Of course, when the Apple retail stores were introduced, there were plenty of experts who thought it was a colossal blunder, second only to Napoleon’s march on Russia. David Goldstein, president of Channel Marketing Corp. told MacWorld Magazine, “It makes absolutely no sense whatsoever for them to open retail stores. Apple will turn the lights off within two years and will have a very bad and expensive experience.” Ouch.
Cliff Edwards of Business Week harped on conflicts with existing retailers such as CompUSA and Sears, quoting CompUSA’s Lawrence N. Mondry, who declared, “When you choose to compete with your retailers, clearly that’s not a comfortable situation.” Mondry could have been describing the experience Mac buyers had when they stepped into most CompUSA stores. It was even worse at Sears. Realizing that they were being held over a barrel by big retailers that were used to calling the shots with computer OEMs and frequently provided a horrible purchasing environment for Apple products, the company did what it had to and took control of distribution.
While Edwards and Goldstein scratched their heads, other analysts were giving Apple a thumbs up. George Rosenbaum, chairman of the market research firm Leo J. Shapiro & Associates, called it a “brilliant idea,” pointing out that Apple retail stores would give the company the opportunity to “leapfrog” past dependence on other retailers. Daniel T. Niles of Lehman Brothers also saw the possibilities, telling MacWorld, “Apple has the ability to start attracting new customers with the launch of their higher-end retail store strategy.”
Niles and Rosenbaum obviously read the tea leaves more accurately than Edwards and Goldstein. Apple hauled in $1.45B from 208 stores in Q2 2008 and plans to have opened a total of 45 new stores during this fiscal year. Consistently the Apple retail stores have been a magnet for customers new to the Mac. Apple claims that half of all Apple store customers are new to the Mac. The combination of Apple’s retail stores and well-implemented online store have helped boost Macintosh sales to record levels. Apple sold 51% more Macs in Q2 than the same quarter last year.
No Wireless. Less Space Than a Nomad. Lame.
You can’t mention the surge in Mac sales without touching on the “Halo Effect” of the iPod. When the iPod was introduced in 2001, many observers thought it wouldn’t fly. I’d been using Macs for years, and while I thought it looked like an exciting device, I couldn’t imagine that Apple would make much of a dent in the MP3 player market. Stephen Baker, an analyst at NPD Intelect, shared my view. He opined that the iPod would likely stand out for its large storage capacity but predicted that the device might have trouble digging out a niche in the market. Others were less kind. Slashdot’s Rob Malda trashed the iPod with this now infamous statement: “No wireless. Less space than a Nomad. Lame.”
Perhaps had Apple simply delivered the initial 5Gb, Mac-only iPod and left it at that, we’d have been right. But before long Apple made the iTunes/iPod combination available for Windows users. That move created several new distribution opportunities for Apple.
First, it gave Windows users the opportunity to try Apple products without having to take the frightening plunge into the world of Macintosh. Apple finally had access to a vast pool of Windows users it had previously been unable to touch.
Second, it opened up a secondary market for iPod accessories and tie-ins. Had the iPod only been available for Macintosh users, a secondary market would have developed, but it would have been much, much smaller. Apple would never have been able to strike deals with auto manufacturers, for example. The connector on the bottom of every iPod (except the shuffle) became the point of entry to an incredible array of third-party products, and as that market grew, the iPod rapidly became the de facto standard portable multimedia device.
Third, it gave the iTunes Store a tremendous head start. While a digital music store is handy in itself, none of the previously-existing stores had made much of a dent in consumer behavior. They didn’t operate particularly well with Windows-based MP3 players, and they didn’t offer broad enough music libraries. Apple struck deals with all the major labels and created a store that provided an easy, addictingly-convenient interface and seamless integration with the iPod. As the universe of purchased iPods grew, so did the market for the iTunes Store.
The integration of iPod and iTunes also created a gestalt effect as Apple moved beyond music. Just as the Apple retail stores bypassed middlemen, the iTunes/iPod combination created a direct link between Apple and its customers. When Apple rolled out movie sales through the iTunes Store in 2006, there was no need to create an entirely new distribution channel. It was already in place. While the iPod helped bring in iTunes Store users who wanted to quickly buy music, the iTunes Store prompted existing iPod users to upgrade to the latest and greatest video-capable iPods. It worked on me, that’s for sure.
As Apple adds more capabilities to the iTunes Store, and does the same with the iPod, the two should continue to energize each other, provided Apple rolls out the right kinds of features. So far the company’s track record is impressive, but competitors are slowly starting to catch up, and Big Media is even getting its act together. The synergistic effect of the iPod and iTunes Store may be losing its power as the competition rolls out viable alternatives, but I think Apple has already seen the writing on the wall and is already creating the successor to the iPod/iTunes channel.
There’s Something in the Air
Apple recognized the potential of wireless networks early in the development of 802.11 (WiFi) technology, and capitalized on it by marrying easy to use wireless routers with built-in wireless capability across the Mac lineup. Apple also realized that the future of computing was mobile. For years Apple has been selling more laptops than desktop machines. So in retrospect Apple’s move into the mobile market was a logical step toward integrating the two trends.
While the iPod was something of a surprise, the iPhone was long-awaited. There were plenty of skeptics who felt that Apple wouldn’t be able to produce a viable mobile phone because companies like Motorola and Nokia had years of expertise in the market, while Apple had none. The subsidizing of mobile phones by carriers was seen by many as a particular problem for Apple. Why would anyone pay for an iPhone when carriers offer cheap or free phones? Bill Ray summed up this line of reasoning in a December, 2006 article in The Register. He wrote, “As customers start to realise that the competition offers better functionality at a lower price, by negotiating a better subsidy, sales will stagnate. After a year a new version will be launched, but it will lack the innovation of the first and quickly vanish.”
Software usability maven David Platt castigated the iPhone development team, writing, “the iPhone is going to fail because its design is fundamentally flawed.” Later in the same post he stated that the market would “severely punish” Apple for its missteps with the iPhone. Consumers, however, have had a different reaction to the device, and Apple says it is confident it will sell 10 million of them this year. Whether they hit the mark remains to be seen. As a point of comparison, Motorola sold over 20 million RAZRs in that product’s first full calendar year of sales (2005).
While Platt focused on perceived design issues, Ray’s analysis was a solid restatement of the prevailing attitude among observers of the mobile market, and it displayed a common underestimation of Apple’s ability to move into new markets. The ghosts of the War for the Desktop still remained, causing may analysts to buy into the myth that Apple was good at making products, but bad at capturing marketshare and blinding them to the reality that for several years Apple has been executing new product launches with nearly flawless precision.
Ray also had no way of knowing that the iPhone would be so innovative. Apple didn’t create another mobile phone. It created a PID (Portable Internet Device), a handheld built around Internet use. The touchscreen interface was just the most obvious new technology; with over 200 patents it is obvious that Apple intends to put up a strong barrier to competitors who seek to mimic the iPhone. Whether software patents are good for society as a whole is debatable, but they’re obviously good for Apple at the moment.
There are all kinds of rumors right now about a new iPhone that may be due in late June, potentially with a subsidy from AT&T that would cut its price by as much as $200. My guess is that Apple will unveil not one new iPhone, but two. One will offer more capabilities for the same price as the existing model, while the second will offer fewer capabilities and will come in a smaller form factor, similar to the mini/nano approach Apple used with the iPod. Of course, we all know about the dangers of punditry. My guess will almost certainly be wildly off the mark.
But if you want to see where Apple’s newest distribution channel is headed, the iPhone is only half of the picture. Sales figures for the iPod touch are not broken out from the rest of iPhone sales, and I think that is for good reason. Apple is covering its bases. If its relationship with AT&T sours, the iPod touch routes completely around mobile networks and runs the same apps as the iPhone. The App Store will carry applications for both devices. Apple would love nothing more than to be rid of its reliance on AT&T. For now it has to go with AT&T, but the iPod touch is Apple’s testing ground for the future. If WiMax or some as-yet-defined successor ever takes off, the collage of WiFi networks that dot urban America will be replaced by much more capable broadband wireless with far better reach, and I believe Apple will be one of the first OEMs to provide an easy way to access it.
If that happens, Apple’s latest distribution channel will be quite impressive. Mobile carriers, despite running the networks, have been unable to do much more than sell ringtones and data transfer at absurdly high prices. Equity Private, the pseudonym for the author of the blog Going Private, takes them to task for their pricing:
$0.10 per SMS at 160 characters per message works out to around $1,000 per megabyte. This is easily 100x the revenue extracted from shipping TCP/IP data over “cellular networks,” with the most expensive providers, and yet, functionally, SMS is vastly inferior to TCP/IP instant messaging services on almost all counts.
Once Apple can get past the annoyance of having to deal with AT&T (and other carriers in foreign markets), the door is open for Apple to provide absurdly cheap access to any and all digital content. Internet and data transfer are already huge draws for iPhone/iPod touch users. If it’s packetized, you’ll be able to access it from an iPod touch. When the App Store launches, iPod touch users will have the ability to buy music, TV shows, movies, audiobooks, and a wide variety of applications. The applications are a very important part of this equation, because as everyone knows from reading about the War for the Desktop, if your wonderful device doesn’t have enough developers creating spiffy applications for it, you won’t gain the benefits of network effect, and you’ll be relegated to second tier status.
There’s been quite an uproar about Apple’s approach to third party application development for the iPhone/iPod touch. In particular there’s been much made of the prohibition against running processes in the background. The success or failure of Apple’s locked-down approach to development of officially sanctioned iPhone apps could be the determining factor in whether Apple’s plan to open up this new distribution channel gains sufficient momentum.Techdirt’s Timothy Lee raises the specter of an overbearing Apple keeping developers from exercising their creativity:
The problem here goes beyond the mere possibility that Apple might block apps that some users would find useful. The more serious problem is the effect that the approval process will have on developers. Given how vague the rules are (what counts as bandwidth-hogging?) and that Apple is free to change them at any time anyway, it’s going to be risky for a developer to start developing an iPhone app that Apple might reject.
Creative developers have also inadvertently given rise to all manner of vulnerabilities and other defects in the world of desktop software, and some observers believe Apple’s model will resonate with consumers who are tired of dealing with insufficiently vetted software. Michael Mace points out that while “Apple takes responsibility for ensuring that iPhones remain secure and do not abuse the network,” no carriers or device manufacturers have been willing to step up to that challenge.
Maybe Building the Whole Widget Isn’t Such a Bad Idea After All
It seems that while Microsoft and Dell had the right model for the 1990s, they may not have the right model for the 2Ks and beyond. Dell is struggling to find a new approach, and Michael Dell has stepped in to take up the reins again. Microsoft tried for years to make it’s software work with a wide variety of third-party MP3 players, then gave up in disgust and created the Zune. The XBox, the only new Microsoft product in recent years to open a new market for the company, is an integrated hardware/software device. Surface, perhaps the most exciting technology to come out of Microsoft’s labs in years, is also an integrated device.
Making the whole widget isn’t the only way to go, obviously. But Apple has done an excellent job of leveraging tight integration to create and expand new distribution channels. The jury is still out on the company’s mobile strategy, but this isn’t the Apple of old. I expect we’ll be seeing more surprises from Apple as it pushes further into wireless distribution of apps and content.
Image Credits
iPod family by Yukinobu Zengame - http://www.flickr.com/photos/zengame/42914278/ - Creative Commons Attribution 2.0 Generic license
Apple Store Ginza by Shunsuke Kobayashi - http://www.flickr.com/photos/bizmac/1401611508/ - Creative Commons Attribution 2.0 Generic license
iPhone - Germany by Rudolf Schuba - http://www.flickr.com/photos/rudolf_schuba/1947181341/ - Creative Commons Attribution 2.0 Generic license
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