Apple is still screwing it up

To my eyes, this is looking like a repeat of the Macintosh-PC Wars of the 1990s which Apple lost. On the one side, you have Apple, competing at the high end and very concerned about platform integrity and control, and preventing other manufacturers from building its hardware. On the other side, you have another operating system designed for the lower end and installed on a host of manufacturer systems – which may or may not cause serious platform integrity problems down the line.  Who wins that battle?

In the 1990s it was Intel and Microsoft. And they went on to reap massive rewards as Apple foundered.  Today, Apple risks a repeat of this if it does not come out with a credible solution to deal with its burgeoning Android problem.

Apple: Can it stop the Android menace?, Nov 2009

According to Gartner estimates, today, we see Android at 25.5% market share instead of 3.5% at this time a year ago when I wrote the intro snippet. Apple is at a still respectable 16.7%, down only slightly from 17.1% last year.  The biggest losers were Nokia and Microsoft. Here is a chart of the figures from Tech Crunch.

gartner-says-worldwide-mobile-phone-sales-grew-35-percent-in-third-quarter-2010-smartphone-sales-increased-96-percent

I won’t say I told you so, because it is still early days. But clearly Apple is still screwing it up. The problem: distribution.

Let me go at this from a side angle. Last month, I was at a friend’s house and his wife was raving about the Nook, Barnes & Noble’s open-source e-reader. She made a lot of good points that resonated with me, especially the part about Amazon’s Kindle format being proprietary. My wife was even more sold based on the looks and readability of the thing. Eventually, we’ll probably get one.  But I had my doubts. See, I am an early adopter who has invested in obsolete technology enough times to be wary of the new, new thing. Remember the wireless internet service provider Richochet?  I was on that.  How about Sony’s MiniDisc players? I was on that too. In fact, I’ve seen a lot of format wars – like Mac vs. Wintel, Betamax vs. VHS, or Blu-Ray vs HD-DVD – and have learned to sidestep these things pretty well now. In a lot of these cases, the losing technology was pretty cool. I loved my Richochet and MiniDisc a lot more than dial-up or a Walkman. But the defining element in each of these format wars has been distribution, not marketing, functionality, or coolness. The company with the most robust distribution channels won – end of story.

The first time, I encountered the ‘distribution’ problem was in 1995 when I was forced to switch from Mac to PC after having used the Mac for the past decade. What was clear to me in making the switch was that Windows blew. Buggy software like Quattro Pro, blue screens of death and troubleshooting an infinite list of incompatible drivers made this clear from the word go. But the reality was that the clones like Compaq, Packard Bell and Dell were flooding the globe with product – cheap product, I might add. They were in every CompUSA, Circuit City, MediaMarkt, Saturn, or Dabs you could visit. I went to them all. Distribution trumps functionality. It trumps coolness.

So when I witnessed the Android problem last year, I knew Apple needed a strategy to respond because it looked like the clone wars all over again (and I am not talking about Star Wars). Google gets this.  They are the IBM of the mobile space, while your Samsungs and Motorolas and HTCs are the Dells, Gateways, and HPs of that space.  What makes the Android story even more compelling is the fact that Google has realized it doesn’t really understand hardware and the important customer service  role that goes with it. They have gladly allowed the Nexus One to fade and let the Android Clones saturate the smartphone market.

Where’s Apple in all of this? Well, they are making some pretty good moves with the iPad and Ping. I like the integration with the Mac and Apple TV. They are doing a great job moving to an integrated cloud-based platform which allows users to use multiple form factors in multiple locations, with access to all the same information and the amazing Apple user experience. I applaud this. But clearly, Apple doesn’t get it even though the noise coming from the statistics is deafening. It’s the distribution.

I am being a bit harsh here because I suspect Apple does get it. What else explains Steve Jobs’ Epic 5-Minute Anti-Google Rant during the last quarterly conference call? Apple sees Google as a threat and is looking to make its case in word as well as deed.  The problem with Jobs’ argument about fragmentation is that it is the same one you could have levelled against Microsoft and the Wintel duopoly during the transition from the shambolic Windows 3.1 to Windows 95 and 98, Millennium, 2000, and NT to the integrated Windows XT platform. Microsoft didn’t get it right for years. And they still won because of distribution.

Now, let’s be clear. The iPhone is still the phone to beat in the smartphone space with the 4G model – irrespective of some of the signal problems. The iPad is still the tablet to beat. I don’t care how much hype you hear about the Samsung Galaxy Tab. It doesn’t measure up. But all of that is as irrelevant as it was in the Betamax – VHS format war and the Minidisc – MP3 Player war. Distribution is what matters. And the easiest, the best way to get distribution is to allow any and all comers to make your product. Apple is not doing that.  Will the end of the AT&T-Apple tie up help? Sure. But it doesn’t get you around the fact that Apple is one company competing against dozens all of whom are very likely to use Android as their preferred platform.

Here’s how I see it shaping up.  Android continues to make huge inroads and developers start focusing more energy on that platform. Either Apple’s market share erodes or eventually they are forced to compete at a lower price point. None of this is a problem near-term as the growth rate is still high. But when growth in the cloud- and mobile-related computing revolution slows, Apple will be exposed.

As Chris Wood pointed out in June:

In all honesty, not only does Apple’s iPad appear overvalued, the whole company does. Assuming the most aggressive growth model, based on a discounted cash flow analysis we figure Apple would be fairly valued today at about $190.00 per share, about 28% below where it now finds itself.

That being the case, you might be tempted to think we’ve found a prime short candidate. Easy money.

Alas, though we love easy money as much as the next guy or gal, we have to say that we would never risk shorting Apple. At least not until Steve Jobs has moved on. This is a special company. The level to which it’s been bid has little to do with the value of the iPad nor the present value of discounted future cash flows. It’s all about the brand.

No two ways about it, people just love them Apples. And as long as that’s the case, the stock is going to trade at a significant premium in the market.

Update 11/11/10:   I am not focused exclusively on the US. When I talk about distribution, I am not just talking about AT&T exclusivity. I am primarily referring to the distribution that is inherent in having multiple hardware manufacturers of your product with their own legacy distribution channels.

In regards to the AT&T issue, Jobs made the right choice at the time and has profited from this. The rev share they got was stellar. He could not have anticipated how quickly Android would have become a competitor. I credit Google here and do not fault Apple. The link-up with Verizon in the US is a big deal and will see Apple making gains.  Apple has been able to get a good revenue share from the reports I have heard. So over the near term, Apple should do quite well.

My concern here is not the profitability of the Android clones or even Google’s Android profitability. What I am concerned about is margin erosion at Apple going forward. Look back at the Packard Bells and Gateways of the PC Wars and you can see that they were not profitable. Microsoft was profitable because they rode the platform and a monopoly to prominence. Google is clever here in looking to monetize Android through search, and music and other services and let the clones take on the distribution.

One thing I should point out in Apple’s defense regarding the ‘Apple vs. an Army of Android clones’ meme is that Apple has seen this through in the past with the iPod when it bested all of the other MP3 manufacturers. The key here was the iPod-iTunes tie. Can Apple do this again with the iPhone? Maybe. Ping is certainly a good attempt to move in this direction. So despite what you hear negatively about Ping in some spaces, strategically it makes sense.

Counter arguments appreciated.

21 Comments
  1. RES says

    As per usual, solid, solid post.

  2. chris says

    excellent article. i’ve been in tech 30 years and wide distribution as well as open architecture always wins. Go waaay back and think VHS vs. Betamax as well. The maxim that marketers (and corp CEOs and Engineering VPs) should always be asked: Do you want to be right, or do you want to make money?

  3. jimh009 says

    Great article.

    I’m one of the 1% of people still alive who do not have (or need) a cell phone. So…I can’t comment about the whole cell phone business.

    But I certainly relate to your experience in switching from Mac to Windows. I started on the Mac too, but was forced to go “Windows” in 1995 too, due to the disappearance of Mac compatible software. What a living nightmare Windows was at that time. Mac was soooooooooo far ahead of Windows back in the 80’s or the 90’s. Yet, Windows not only was the most popular OS but kept gaining in popularity.

    Like you said, it was all about distribution. Only thing I might add is that distribution isn’t the “only thing.” Windows computers have always been less expensive than Mac’s, even back in the 80’s and 90’s. Price does matter, especially if the price difference is substantial as is often the case when comparing Apples vs. Windows computers with similar technical specs.

  4. jimh009 says

    Also, one thought regarding the Kindle vs. Nook/Open platform debate. One thing that will prevent the Kindle from becoming the 1990’s Apple is that a person can read Kindle ebooks on any platform that has a Kindle App installed, even their home computer. And Amazon gives that app away for free. As such, Kindle books aren’t limited to only one platform like Apple software used to be.

    The big worry for Kindle, I think, isn’t the closed format of Kindle books but is instead being surpassed on the hardware side by platforms such as the iPad. As long as the Kindle can remain competitive in price and features (in particular, by offering color) with other ebook readers, I don’t see Kindle quietly fading away into the night. This is especially so because Amazon dwarfs Barnes and Noble in online book sales and in overall online presence. Amazon makes it awfully simple to buy kindle ebooks and read them on either a Kindle e-reader or other platform that has the kindle app installed. Until Barnes and Noble figures out how to compete with Amazon online, I don’t see the Nook posing much of a challenge to the Kindle.

    1. Edward Harrison says

      I am with you on the Kindle. It’s the Nook I think could end up being obsolete.

  5. Pol says

    Thanks for the insight, Edward, but you’re missing the bigger picture: making money is the name of the game, not selling the most widgets. With only 7% market share, the Mac accounted for 35% of worldwide industry profits in 2009 (http://www.businessinsider.com/chart-of-the-day-revenue-vs-operating-profit-share-of-top-pc-vendors-2010-3). Wouldn’t you say that’s winning in the Mac-PC wars?

    The iPhone has a 4% market share, but a 50% profit share (http://www.asymco.com/2010/10/30/last-quarter-apple-gained-4-unit-share-22-sales-value-share-and-48-of-profit-share/). With Android coming on strong, can this bottom line dominance be sustained?

    Since Apple’s business model, building a premium integrated product for a premium price, has proven successful over time with the Mac, here’s how I see it shaping up. Android continues to make huge inroads and some developers start focusing more energy on that platform, while others keep focusing their energy on iOS and yet others work equally on both. Apple’s mobile phone profit share, though its market share might erode somewhat, remains at an outsized level, as consumers, just like for the Mac, keep rewarding it for producing a premium integrated product by paying a premium price, while the Android clone manufacturers, with no significant differentiating factor, just like Windows PCs, must compete on price. The clones sell a lot of phones for small profits, while Apple, as for the Mac, sells fewer phones for the lion’s share of profits (http://www.asymco.com/2010/10/31/making-it-up-in-volume-how-to-view-unit-profitability-vs-volume-in-handsets/).

    To recap,
    1. Apple will keep winning big with phones just as it’s won big with the Mac,
    2. the Android OS provider, Google, will win big, just like Microsoft with PCs,
    3. some Android phone makers will win less, just as no PC maker (HP, Samsung, Dell, etc.) is more profitable than Apple and
    4. some Android phone makers will get obliterated, just like some PC makers got trounced (Remember Gateway?).

    You’re right: iPhone vs. Android is a repeat of Mac vs. PC. You’re however wrong in using market share as the measure of success. Considering the true measure of success, profitability, Microsoft has won in computers, but so has Apple. As for mobile, Google will win big with Android, but so will Apple with its proven integrated model. The generic hardware makers are once again condemned to, at best, lower profitability or, at worst, extinction.

    As for AAPL’s valuation, would you please share which metric is used to claim that it trades at a significant premium to the market?

    Regards,

    Pol

    1. Edward Harrison says

      My concern is not the profitability of the Android clones or even Google’s Android profitability. What I am concerned about is margin erosion at Apple as I indicated. So clearly I am focused on the issue you address. Google is clever here in looking to monetize Android through search, and music and other services and let the clones take on the distribution. This saddles Apple in a battle of one against an army. Eventually growth or margins will erode.

      1. Pol says

        What would happen if, as you suggest, Apple allowed any and all comers to make its product (at least something similar thereto) by licensing its OS? It would lose one of the elements that differentiates it from the pack. If HTC or Samsung could make an iOS phone for $500 (unsubsidized), some consumers might elect not to pay $650 for an iPhone. Wouldn’t Apple lose some pricing power and face margin erosion?

        The distribution argument would work if Apple, like Google, were only selling an operating system. In this instance, if it licensed its iOS to two or three manufacturers while Android were available to all, then Apple would be at a disadvantage. Apple is however selling the whole experience, not just an OS. Hasn’t Apple been facing an army in the computer market under similar circumstances? With a 35% profit share, hasn’t it been winning in that battle? The Mac has shown over time that consumers are willing to pay up for a superior integrated experience. The Mac and iPhone are greater than the sum of their parts.

        History shows that Apple and Microsoft were the big winners in personal computers by using different models. Using a similar approach, why wouldn’t Apple win in the smartphone space? It has won and will keep winning.

        Will Apple’s growth or margins erode eventually? Growth will erode when the market matures. Margins will remain healthy. Will Apple keep making the lion’s share of profits compared to other phone makers? Yes, and this is what matters most. The Android clone makers will win the battle for unit share in aggregate, but Apple will win the battle for profit share. Google will win using an approach similar to Microsoft’s in computers. It’s not a zero sum game.

        Apple is not screwing it up: it gets it, by sacrificing some unit share to maximize profit per unit sold, while the Android pack fights it out with little to differentiate one from the other.

        1. Edward Harrison says

          I don’t have an answer to that because you’re right about the margins erosion. I think it’s really about hardware being a tough business in which to maintain high margins. If I were Jobs I might license the OS the way Microsoft did and try that route. Gil Amelio tried this with the Mac but it was too late by then.

          1. Pol says

            Hardware is a tough business in which to maintain high margins for a company that can’t offer something much different from its competitors.

            To wit, if you want to buy a computer, your fundamental choice is between a Mac and a Windows PC, not between an Apple, a Toshiba, a Dell, an HP or an Acer. If you value the Mac OS, your only option is to buy an Apple computer. If you go the PC route, then you must choose among many different manufacturers. What’s different between them? They all run Windows and they all make machines that meet your hardware specifications. A Sony happens to be the weekly special at Best Buy. You might have preferred an HP but the discount entices you to buy the Sony. Because Apple is able to offer a significantly different product, highly valued by consumers, it doesn’t have to compete on price, hence maintaining high margins. Its Macs are not commodities.

            Likewise, if you’re in the market for a smartphone, your fundamental choice is between an iPhone and an Android phone, not between an iPhone, a Samsung Galaxy S, an HTC Droid Incredible, a Motorola Droid X, etc. If you value the iPhone OS, you can only buy from Apple. If you choose Android, then you have a lot more options. The HTC might offer a better camera, the Motorola might offer longer battery life, the Samsung might have a bigger screen, but they all run Android. There’s not much difference between them. You might prefer the HTC but Verizon is offering the Motorola at a discount this week. You take the deal. With little difference between them, the clones must compete on price, lowering their margins.

            By keeping its OS to itself and through continuous innovation, Apple is a able to offer something significantly different, valued by consumers. Since it has a monopoly on that product, it doesn’t compete on price. Its proprietary OS is its biggest asset and it would hence be a mistake to share it.

            Another important consideration is the fact that, unlike MS, which gets royalties for Windows, Google is giving Android away. How would Apple monetize its OS if it decided to license it? Can it offer the services Google will use to make money from Android? Would it make the $238 it now makes on every phone (http://www.asymco.com/2010/10/31/making-it-up-in-volume-how-to-view-unit-profitability-vs-volume-in-handsets/)? Would it make half as much? It probably wouldn’t and it would cannibalize its own sales. Licensing its OS would destroy Apple’s margins.

            The problem with the Mac in the 1990s was not that Apple did not license the Mac OS, it was that the company stopped innovating and consumers were unwilling to pay a premium (or even money, for that matter) for its computers. Licensing the OS just cannibalized its sales, so Steve Jobs immediately put an end to the program upon his return. The Mac started growing again through innovation (all-in-one iMac, Mac OS X, Boot Camp,…).

            In short, there’s nothing wrong with Apple’s strategy. It doesn’t have to sell the most phones to win. As with the Mac, it has chosen to sell the most profitable phones, through innovation and differentiation from its hardware competitors. Its market share will not catch up to Android’s, but will remain high enough to generate the greatest profit share, while the Android clones fight for the scraps. Let’s not try to fix something that isn’t broken.

  6. Edward Harrison says

    Pol You make a compelling argument. Your comments about hardware demonstrate why I wouldn’t necessarily want to license either. In many ways Apple is a better run Sony that gets its money from innovation design and brand. There is nothing wrong with that strategy. The problem is valuation and how to deal with Android. The mobile space is not naturally one for rent seeking like Microsoft in PCs. There is room for three OSs. So Apple will do well here. The question is how well and whether they can prevent Android from becoming the OS that dictates standards. I may have more later.

  7. Pol says

    I don’t understand rent seeking, Edward, but look forward to further commentary.

    As long as Apple is able to offer a superior package (design, hardware, software, cloud services, integration with other products, outstanding customer service, etc.), it will command a premium price on the market. Since iOS is its most important differentiating factor, it would be counterproductive to share it with its competitors. Innovation and differentiation are its keys to success. That’s how it will deal with Android. The iPhone, like the Mac, will never be within everyone’s reach, so it won’t win the unit share battle, but it will generate the highest profits and that’s the end game.

    As for valuation, Apple’s earnings will grow by about 70% this year (http://bullcross.blogspot.com/2010/07/2010-year-apple-enters-new-golden-age.html). Growing its earnings at half that rate in 2011 (a very conservative assumption in light of its momentum) would put its PEG at 0.6 (20.9 P/E divided by 35). Expect a much higher stock price at this time next year.

  8. John Creighton says

    So if there is only room for three Operating systems who do you predict gets the third sort Nokia’s (Symbian OS) or research in motion. For RIM the torch looks pretty cool and the playbook has some amazing hardware specs for a tablet. I am not sure what Nokia’s top products are but the brad does quite well world wide.

  9. Pol says

    Edward, In response to your 11/11/10 update, as I’ve argued in my previous posts, not only isn’t it desirable for Apple to have multiple hardware manufacturers of its product, it’s also impossible because Apple doesn’t only produce an OS, like Google does with Android, it makes the whole enchilada. Its product is an A to Z experience (superior design, quality hardware, proprietary chip, industry-leading software, no bloatware, friendly shopping experience, out-of-the-box functionality, ease of use, outstanding customer service,…). Its competitors might be able to equal or best some of these aspects, but not the whole. Therein lies its advantage. Giving away its OS, likely its main differentiator, would cheapen its product and render it less desirable, just like BMWs would become less desirable if BMW allowed GM to market its chassis and logo.

    By maintaining full control of the iPhone experience, Apple prevents it from becoming a commodity like all the Android clones and, so long as it’s able to produce a superior experience on the whole, ensures premium pricing and high profit margins.

    To complete the analogy to the PC market, Google is positioning itself to be Windows (though its model may be more difficult to monetize.), the Android clone makers are Packard Bell, Gateway, Dell and HP, while Apple is Apple. Apple belongs to a different category because it makes a different product. Google and MS make an OS, Samsung, HTC, Dell and HP make hardware, while Apple produces an integrated product.

    With this model, Apple has managed to produce great profitability in computers. The same model is also working in the smartphone space. So long as it can execute, it will keep winning the lion’s share of profits, just like in computers. In fact, I would say that it’s better positioned than Google because Apple is already monetizing its product, while Google is still trying to put the pieces together. Its lack of control over its software is worrisome for its strategy, as Verizon’s pre-installation of Bing on some Android phones in lieu of Google search reveals (http://www.broadbandreports.com/shownews/Verizon-Bing-Wont-Be-Exclusive-On-All-Android-Phones-110294). Might Google be experiencing problems monetizing Android and hence reverting to producing its own branded phone (http://www.engadget.com/2010/11/11/this-is-the-nexus-s/)?

    Margin erosion is likely (Isn’t that an outcome in all competitive markets?), but its sound model will enable Apple to overcome it. No worthy competitor to the iPod emerged, such that Apple owns the MP3 player market in both unit share and profit. This isn’t the case in smartphones. Nonetheless, Apple proved in computers that its model can win the highest profit even without selling the most units. There is nothing Apple can do to stem the Android tide. The licensing cure would certainly be worse than the disease. Apple just needs to keep executing its strategy.

    1. Edward Harrison says

      Apple co-founder, Steve Wozniak, has never been one to mince words. Today’s no different as demonstrated in an interview with the Dutch-language De Telegraaf newspaper in The Netherlands. The first revelation is an admission that Apple had collaborated with a well-known Japanese consumer electronics company in 2004 to develop a phone that was ahead of its time. Woz is quoted as saying that while Apple was content with the quality, it “wanted something that could amaze the world.” Obviously, the phone was shelved followed by Apple’s announcement of the iPhone in January 2007.

      Woz then moved on to the topic of Android saying that Android smartphones, not the iPhone, would become dominant, noting that the Google OS is likely to win the race similarly to the way that Windows ultimately dominated the PC world. Woz stressed that the iPhone, “Has very few weak points. There aren’t any real complaints and problems. In terms of quality, the iPhone is leading.” However, he then conceded that, “Android phones have more features,” and offer more choice for more people. Eventually, he thinks that Android quality, consistency, and user satisfaction will match iOS.

      http://www.engadget.com/2010/11/18/steve-wozniak-android-will-be-the-dominant-smartphone-platform/

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