Asymco

Asymmetric Intelligence

Theory

  1. The cost of building Galaxies (and iPhones)

    Research · 33 comments

    Although Samsung and Apple are acclaimed as the leaders in profit capture for smart (and otherwise) phones, what is not lauded is how much they spend on capital equipment used in the making of these phones.

    In 2012 Samsung spent around $20 billion while Apple spent about $10 billion (excluding leasehold improvements or Apple stores but including real estate).

    Compare these figures with Intel at $11 billion, Google at $3.2 billion, Microsoft about $2.8 billion and Amazon $3.8 billion (including presumably new distribution centers.)

    Screen Shot 2013-04-04 at 4-4-5.51.15 PM

    What each company spends on differs depending on its business model, but as the graph above shows it's easy to see that there is a class of "big spenders" who spend so much that it makes it hard to imagine just what $10 billion/yr could actually buy.

    To get an idea of just how big that figure is consider that a Nimitz class aircraft carrier costs about $4.5 billion to build and it takes several years to do it. Or consider that the largest data center in the world probably costs about $1 billion or that the largest office building will cost between $4 and $5 billion. Either of these infrastructure projects are massive multi-year projects. Apple, Intel and Samsung spend well more than this every six months.

    So it's a special class of equipment which falls in the multi-billion dollar range: semiconductor process equipment.

    Whereas in the case of Intel it's the obvious target for the funds, how can we assume it's the case for Apple and Samsung.

    We don't have proof but there is a remarkable correlation between CapEx and Semiconductors in Samsung's divisional financial reports:

    Screen Shot 2013-04-04 at 4-4-5.58.22 PM

    We also have the historically reported allocation of CapEx as reported prior to 2008:

    Screen Shot 2013-04-04 at 4-4-6.00.26 PM

     

    Therefore I consider it safe to assume that the bulk of Samsung's Capital Expenditures are in support of semiconductor production (note that this does not include display panels).

    Note however that in the first graph, Samsung's expenditures seem to be declining. Measured in Won, the level in Q4 '12 was about the same as that in Q1 2010 and down 30% y/y. Apple's spending also dropped sequentially in Q4 but was up 75% y/y. It's also nearly ten times higher than what Apple spent in Q1 2010.

    So the question I would ask is whether Samsung's reduction CapEx (which is safely assumed to be supporting semiconductor production, and which, in turn, is, to a large degree, supporting Apple) is being picked up by Apple.

    If so then then this would be evidence of the re-alignment of role and control in the value chain of a terribly important industry.

  2. LG's new Tele-vision

    Research · 17 comments

    LG Electronics has acquired HP's WebOS for an undisclosed amount. When last it changed hands WebOS was part of Palm which was purchased for $1.2 billion in 2010.

    Palm has thus been effectively divided into several smaller pieces distributed as follows:

    HP will own:

    • Support of existing Palm users
    • Palm back-end assets including source code, infrastructure and talent
    • webOS patents

    LG will own:

    • Stewardship of the Open WebOS and Enyo open-source projects where the source code resides
    • Associated talent
    • WebOS websites
    • License for IP related to webOS

    LG announced that it plans to offer an "intuitive user experience an Internet services across a range of consumer electronics devices." In an interview, the CTO of LG said that given the current situation with Android, LG does not plan on making smartphones running webOS but will use it in televisions and other devices such as cars, signage and appliances where there are no embedded OS's. "We'd like to secure a software platform across all devices."

    Most commentary regarding the deal focused on the use of the platform for TVs but management seems to consider all devices, perhaps even phones, at some future date, to be webOS targets.

    The TV however seems to be low hanging fruit today. The TV as an app platform will be the new ecosystem war and no platform today has a lock on the developers or users. The way this rivalry will shape up will not mirror other device classes for the same reason that current device classes are platform silos.

    PCs, music players, tablets and phones all have different super-majority platform leaders. The association of a platform with a device class depends first on the distribution model, which favors a specific business model which favors a specific vendor which favors a specific platform. As each device is distributed differently, a different platform takes precedence.

    Consider that the PC has historically been purchased by IT departments which led to a monoculture of Windows which led to a persistent leadership for Microsoft.

    The music player created dominance around iTunes mostly because the distribution model for music labels was baked-in. With network effects, the iPod quickly gained and perpetually retained market share leadership.

    The smartphone business initially favored Symbian and BlackBerry because they had the market access through operators. After the touch UI became dominant (and incumbents failed to respond in a timely manner), Apple and Google took leadership as soon as they accepted the operator distribution model. Android in particular is especially resonant with operators and has been developed with their requirements in mind.

    The tablet business is more like the PC business but without enterprise requirements or patterns of purchase. This has meant that app/content ecosystems and retail distribution were the key gating factors. The story is still unfolding but so far Microsoft has not found a foothold while iOS and Android and Amazon have.

    That leads to the question of how will smart TVs be sold and which business model (or go-to-market strategy) will succeed. Steve Jobs pointed out the difficulty in trying to deliver innovation into a value chain dominated by cable companies which can effectively block it. A TV which is an application execution device rather than a content terminal will require a re-definition of the category. That will require a re-positioining of this product. Few companies are able to do that. [See also my post Tele Vision from mid-2011].

    Which brings us back to the question of webOS. As long as LG sells TVs as content terminals they might not obtain much value from webOS. If, on the other hand, LG were to use webOS to re-define their televisions to be something else entirely, namely software execution devices, sold differently and hired to do a different job than a TV, then webOS becomes not only necessary but potentially a source of great prosperity.

  3. Are the ecosystem wars won on the factory floor?

    Research · 13 comments

    I'll be speaking at the Harvard Business School Technology and Operations Management Digital Seminar Series on "The evolution of value chains in a computing markets measured in the billions of units per year."

    ​Abstract

    2013 will see two billion phones shipped into a market of over 6 billion points of network connectivity for over 4 billion consumers. In addition to phones, there will be a few hundred million more tablets and mobile computers shipped. It's very likely that the majority of these devices will be "smart", meaning designed to be a part of an ecosystem of software, content and services. Contrary to the common assumption that larger markets sustain more competitors, this immense and rapidly growing market has become profitable for only two device vendors. The reason is that the windows for competitive advantage are fairly narrow and although production can be ramped more quickly than ever, the resources needed are available to few.  The frequency and amplitude of market flux benefits only those who can operate at scale and punishes those who can't. Close observation of the investments of these "superpower" competitors shows an extraordinary level of capital purchases of manufacturing equipment, regardless of their nominal position in the value chain. These capital expenses have been growing in proportion to in the frequency of product launches. I present data showing a correlation between manufacturing equipment CapEx and ecosystem success and put forward a hypothesis that this relationship is causal. I also discuss the implications for ecosystems owners with regard to the processes, resources and priorities necessary to succeed in this evolved value chain.​

     

    The event is open to the public and taking place March 7th, 3:00PM to 4:30PM in the Cotting Conference Room.

  4. Why doesn't anybody copy Apple?

    Research · 237 comments

    Apple's products are the envy of the world. They have been spectacularly successful and are widely imitated, if not copied. The expectation that precedes a new Apple product launch is only matched by the expectation of the replication of those products by competitors.

    This cycle of product mimicry was succinctly summarized by Marc Andreessen regarding a rumored Apple TV product:

    And once the television launches, everyone will scramble to copy it. "There's a pattern in our industry, Apple crystallizes the product, and the minute Apple crystallizes it, then everyone knows how to compete."

    This idea that the basis of competition is set by Apple and then the race is on to climb the trajectory of improvement is so well understood that it's axiomatic: "It's just the way things are." Apple releases a product that defines a category or disrupts an industry and it becomes obvious what needs to be built.

    But what I wonder is why there isn't a desire to copy Apple's product creation process. Why isn't the catalyst for a new category or disruption put forward by another company? More precisely, why isn't there another company which consistently re-defines categories and repeatedly, predictably even, re-defines how technology is used.

    Put another way: Why is it that everyone wants to copy Apple's products but nobody wants to copy being Apple?

    Note that I don't suggest that there isn't a capability to copy. It may or may not be possible, but capability comes after desire and without desire there can be no capability. What I'm suggesting is that there isn't a desire to "be like Apple". If there were a desire, we would be seeing a massive search and debate into what makes Apple successful. Management consultants would be pounding the pavement pitching the "Apple way". Wall Street would be sizing up companies to a standard of "Apple-ness" and rewarding those who conform and punishing those who don't.

    None of this is happening. I can think of two reasons why:

    1. Apple is not to be imitated because it's not worth copying. I.e. Apple is not a successful company.
    2. Apple is successful but Apple cannot be copied because its success is a magical process involving sorcery.

    There is a great deal of evidence for the first hypothesis. The idea of Apple being successful is not something reflected in its stock price. Being valued at a lower P/E ratio than its competitors, and indeed lower than the average company in the S&P 500, indicates that to whatever degree Apple was successful in the past, it's not seen by the vast majority of observers as successful in the future (no matter when you choose to make this observation).

    Why should one bother copying Apple if it results in being punished with a low valuation? You work really hard at innovation and then that innovation becomes commoditized very quickly. Why should one bother?

    And yet if we look outside the investor community, especially if we ask operational managers and entrepreneurs, there are some who would say that Apple is actually a success story. However, when asking innovation practitioners what makes Apple successful the answers regarding the causality of this success border on the mythical. Answers which reference "skills", "culture" and "teams" abound. The culmination of this hypothesis is the "chief-sorcerer" theory of success which places one magician in charge of casting all the right spells. These resource-defined explanations are unsatisfactory because they are vague. Without specificity they don't help us understand why they can't be copied.

    But what about Apple's own opinion of what makes it tick?

    Bill C. Shope: How do we think about Apple's culture of innovation today?

    Timothy D. Cook: Innovation is deeply embedded in Apple's culture. The boldness, the ambition, the belief that there are no limits, the desire among our people to not just make good products [but to] make the very best products in the world. It's in the values. It's in the DNA of the company.

    Now if you look at some essentials for innovation, there is no formula.
    If there was a formula, there would be a lot of companies that have a lot of money that would gone out and bought their ability to innovate.

    Some of the essentials for us are skills and leadership. Apple is in a very unique, and, in my view, unrivaled position because Apple has skills in software, in hardware, and in services.

    […] arguably, where you can innovate in hardware, [where] you can innovate in software, [where] you can innovate in services; the real magic happens at the intersection of these.

    And you know, the iPad is very magical. And it's exactly because our company was doing all of those things. And so for many years this idea ... [which] some people call vertical integration, ... it was out of favor. People thought it was kind of crazy. And we never did.

    And so through all of those years, we continued to build. And these skills, this isn't something you can just go write a check for. This is something that you work decades for. Building this experience. And so I think we bring that. I think we're unique in that. I think we're unrivaled in that. I think there are people trying desperately to catch up in that. And I think they're finding that it's not so easy to do.

    Tim Cook refers to integration and a great team as unique Apple advantages (but also note the references to magic and belief.) It's a better explanation but it is still hard to understand why nobody copies this approach. Integration is something that can take a long time, but it is possible with a Herculean effort. A few companies are starting to make moves in that direction (e.g. Microsoft.) But efforts are half-hearted. There is no "move the Earth" panic to become an integrated company from Samsung, Google or Microsoft.

    Maybe others haven't quite balanced both the cost and the benefit of being Apple. It's clearly still mysterious and unclear why one would want to do this. It's much easier to use what you already have and how you operate to copy what Apple produces rather than how they produce it.

    My own suspicion is that Apple is more aware of what makes it special than they are letting on. In other words, I believe that Apple is self aware but being careful not to share what it knows. However, as Tim points out, it's not a formula. There is no silver bullet, no single trick.

    It's complex, it's subtle, it defies explanation but it's not magic. It's a process that requires a degree of faith and fortitude. It's collecting but ignoring data and trusting judgement when data tells you to move in a different direction. It's a lot of willful rejection of conventional wisdom. It's asymmetric approaches to competition. It's art as much as science. And most of all, it's a lot of mind-numbing polishing while trusting that only by doing great work is survival even possible.

  5. A short interview with Jasna Sykorova

    Research · 22 comments

    A short interview for iCon where I'll be presenting tomorrow. The interview originally took place on January 9th, 2013.

    Jasna Sykorova: You have focused on mobile devices for some time now. What made you to start to give a special attention to Apple related data?

    I began to look at Apple in 2005; long before they were in the phone market. I had an iPod and liked the Mac but I did not have particular reason to think about the company. You might find it strange that it was the launch of two very peculiar products that caused me to change my perception of the company. They were the iPod Shuffle and the Mac mini.

    These are not seen as important today nor were they back then.  But they signaled to me that something dramatic was happening: the company was shedding its "premium" image. This and the earlier move of iTunes to Windows signaled [to me] that Apple was serious about the mass market and the minimum price that a person would need to pay to become an Apple owner.

    This was pivotal to me also from the point of view of disruption theory. If a company takes the fight to the low end it means it protects itself from a low end disruptor and may even enter new markets. So if the thinking is that Apple would disrupt then it would have to get into new categories. I then asked myself what it would target. I told myself (again, in 2005) that Apple will do three things:

    1. build a phone
    2. disrupt the PC market
    3. enter the living room.

    1 and 2 are well understood to have happened and 3 is nearly here with Apple TV.

    Each of these were tremendous opportunities and it's been fun watching it happen over the last 7 years.

    By the way, my expectations were right not because of any insight into the company. I had not studied Apple much at the time. All my expectations came from understanding the psychology of a disruptor. Nor does it mean that what Apple did was deliberately planned. It's possible to predict what people will do even if they don't know what they will do themselves.

    Can data tell stories? Can you judge just by data?

    Data tells amazing stories but not without an interpreter. Having data without a storyteller is like the tree falling in the forest and nobody being there to hear it. If the data's story is not interpreted then does the story actually exist? Did the data "make a noise"? It's a question for philosophers.

    Practically, it's important not to base decision making on data alone. Data only exists about the past. Clay Christensen blames God for making us suffer in this cruel way. The past sometimes reveals patterns that help us predict the future, but it's hard to see some patterns. You may need to look at long time frames and there's never enough data. What is more helpful is to have a theory.

    Science works this way. Data helps build a model and the model helps build a theory and that theory is tested over time and adjusted. Unfortunately, we don't have very good theories about how businesses should be run. I used to say that if Business Management was a science it would be like medicine in the Middle Ages: mostly superstition and faith in the powers of individuals. [We need to move forward from this.] That's what I'm doing with my work: trying to build and test management theories. The data is just the first step on that road.

    What is the difference between Apple in the time of Steve Jobs and Apple now?

    Steve Jobs was a very important influence in the DNA of Apple. I think his influence was so deep that it existed even when he was not there in the 90s and I think it exists to this day. The influence is in the priorities, values and culture of the company. These influences exist in all companies and are very hard to change. They are almost never put in writing or even discussed. They are dogma, constitutions or doctrine by other names.

    Processes and assets may change however. I think decision processes will change at Apple. I suspect there will be more discipline in that regard and more rational ways of doing things. That could be good or that could be bad. But the passion to be great will not change. That's what the brand speaks to each employee. They are there because they want to be part of that greatness.

    You will speak about Apple's strategy for enterprises at the iCon. Do you consider it a “new wave” of activities of Apple? What chance does it have against the strong corporate players like Dell? And what benefit can iPad have for a company, if any?

    If you look at my list from 2005 you don't see Enterprise on there. I think it might have joined the list since then. But it's not obvious yet. The thing is that Apple's approach to Enterprise will not be typical. It will be disruptive. It will be subtle and "easily ignored". This is what I want to discuss. The incumbents are not noticing Apple even as they are losing significant value to Apple in their core markets.

    Analysts (and consultants) find all kinds of reasons to downplay Apple's efforts and comfort the organizations who hire them [which is why the approach is generally unfelt]. Also IT is changing in the jobs it's hired to do. These are all good signs that something is happening. Something that will become very quickly a fait accompli.

  6. The job the iPhone is hired to do

    Research · 94 comments

    In the latest quarterly report Apple changed how it reports product revenues. In previous quarters the iPhone and iPad were reported including accessory revenues while iPod accessories were reported under "Music" revenues.

    "Under this new format revenue from iPhone, iPad, Mac and iPod sales is presented exclusive of related service and accessory revenue […] revenue from all Apple and third party accessory sales is presented as a single line item [Accessories.]"

    Apple provided a document showing re-classified product summary data.  By measuring the difference between original revenue and re-stated revenue per product we can determine how much service and accessory revenue was being attached to each product.

    I did this for two quarters as a sample:

    Screen Shot 2013-01-24 at 1-24-2.16.14 PM

     

    The analysis shows that the iPhone has been receiving about $15 of accessory attached value and the iPad about $25. Interesting trivia, but how is this insightful?

    Consider the impact on this analysis of revenues/unit shipped:

    Screen Shot 2013-01-24 at 1-24-2.31.52 PM

    The iPhone obtained about $642 revenue/unit (shown above as the last datum in the green line). That compares slightly lower with last year's $659/unit. However, the latest quarter is on the new basis and the data in the chart above shows old basis.

    Here is the data with re-stated iPad and iPhone ASP:

    Screen Shot 2013-01-24 at 1-24-4.29.37 PM

    On a re-stated basis, without the extra revenue from accessories, the iPhone "ASP" (Average Selling Price) from a year ago becomes $646 (which, again, is not what is reflected in the graph). This is almost exactly the same as the current quarter. The iPhone "ASP erosion" therefore goes from 2.6% to only 0.7%.

    Similarly, the iPad shown at $467 in the latest quarter does not drop from $593 last year but from $568. Its ASP erosion becomes 18% rather than 21%.

    Interesting resilience with the iPhone and slightly better support for the iPad price. What does it mean?

    Pricing power is the most important indicator of differentiation and it implies an ability to create value in excess of cost. Not only that but it also indicates whether a product is being "commoditized" by over-serving the market and being substituted by lower priced alternatives.

    In the case of the iPhone the tenacious retention of its ASP indicates that the point of over-service has not been reached. Buyers are not yet switching in significant numbers to the older, cheaper variants available from Apple. If they were we would see evidence in the price first due to the change in mix.

    Contrast that with the iPad where there is a far more marked erosion. That's due to the introduction of the mini which is good enough to substitute for the larger version for many of the jobs it's hired to do. We can safely argue that the iPad is good enough in smaller form factors and addressing larger markets.

    But why isn't this happening to the iPhone? Why isn't the iPhone n-1 "good enough"? Surely consumers can do almost the same tasks with an iPhone 4S as they can with the 5. Why are they still buying the new phone?

    The clue comes from the fact that the consumer is not the only buyer. It's  operators who buy and re-price the product. They are hiring the product to sell broadband and the newest variant is still the best hire to do that job. This observation is crucial to understanding the growth dynamics of the iPhone and consequently, of Apple itself.

    I repeat what I've mentioned before: The iPhone is primarily hired as a premium network service salesman. It receives a "commission" for selling a premium service in the form of a premium price. Because it's so good at it, the premium is quite high. Also because it's so good, it gets bought in large batches which allow Apple to schedule production efficiently.

    This understanding gives us a solid basis from which to evaluate its growth potential.

  7. How much do maps cost and what are they worth?

    Research · 66 comments

    How much does it cost to have the world's best maps?

    The answer may seem simple: $8.1 billion.

    That was the cost to Nokia in cash for buying Navteq in October 2007. It would seem that buying that asset (or another one like it) is a cut-and-dried solution to anyone needing a mapping "solution". But it's not an answer that is either complete or explanatory of how mapping solutions are valued.

    Navteq was not priced as a database for an app. It was a business which was expected to create licensing revenues and profits[1]. The actual price for this business net of cash was $7.7 billion but the following graph shows the net sales and operating profits since Nokia began reporting its performance:

    Screen Shot 2012-12-18 at 12-18-3.13.12 PM

    The blue area represents the difference between sales and costs and hence the operating expenses--the payments needed to "keep the lights on".

    These total expenses over the 4.25 year time frame totals €6.5 billion. The total operating losses equal €2.6 billion. Therefore, as far as Nokia's shareholders are concerned, they paid $11 billion for Nokia maps, to date.

    What do they have to show for it?

    Nothing. The entire company is now worth only about $15 billion. It's hard to imagine maps being worth 73% of Nokia. What Nokia hoped to get for the product was some value in its devices. As other issues intruded, that value has not been realized. Nor has any external licensing revenue been realized. Net external licensing revenues are actually decreasing.

    The situation looks even even uglier when the maps asset can be seen as costing €1.5 billion every year. Why would anyone want to be in this business?

    I bring this up because, apparently, everyone wants to be in this business.

    Via Twitter I received a suggestion (rumor?) that Google spends about $1 billion every year for maintaining their maps. (Using a conversion from Euros to Dollars yields a Nokia maps burn rate of nearly $2 billion/yr.) Furthermore, there seems to be a burning desire for Apple to also burn this money.

    If so, then Apple might have to start spending $1 to $2 billion/yr to merely maintain a data set. That would be a minimum of an additional 7% in operating expenses.

    Why would they do that?

    If Apple cannot buy or license quality data, there may be no choice. Maps have become a hygiene factor for a platform. Not having them makes a platform repulsive but having them offers no attraction.

    Another way of looking at the maps asset is like a component in a phone. A vendor needs a certain class of processor, memory or screen or battery. Not having a minimum level of functionality makes the product uncompetitive but having it does not guarantee success.

    What's worse, the market may have been cornered—there may be no suppliers. Unlike hardware components, the maps component is not a commodity with a market of suppliers. The work needed to maintain the maps is a commodity but the aggregation and consolidation of the data is valuable and those who have gained control over the data and they are not likely to license it to any competitors for strategic (i.e. political) reasons.

    So we have a perverse situation of a very costly, unprofitable asset requiring duplication of maintenance effort by politically motivated actors imprisoned by their own strategic interests.

    If so then it fits perfectly with the mobile telecom industry. Like mobile networks, maps are very expensive and worth very little.

    ---

    Notes:

    1. The revenues that Navteq was obtaining during the 2008/2009 time frame included that from customers such as Verizon, Garmin, Advertising, Traffic services, Microsoft Windows Live services. For the six months ended on December 31, 2008, Europe accounted for 44% of NAVTEQ’s net sales, North America 43%, Middle East & Africa 8 %, Asia-Pacific 2 %, Latin America 2% and Greater China 1%.

    —

    If you want to learn more about how to analyze technology industries and the evolution of value chains, consider participating in Asymconf.

  8. The real threat that Samsung poses to Apple

    Podcast · 429 comments

    [The following is a post written by James Allworth.

    James is the co-author of How Will You Measure Your Life?. He has worked as a Fellow at the Forum for Growth and Innovation at Harvard Business School, at Apple, and Booz & Company. It follows and builds on a discussion we had on the 56th Critical Path podcast.

    You can connect directly with James on Twitter at @jamesallworth -ed]

    A lot of ink has been spilled in the wake of the recent Apple Samsung patent disputes, and the legal wars see no sign of abating any time soon. The rise of Samsung's phone business has been meteoric, and Apple is right to be concerned. But the real threat that Samsung poses to Apple has very little to do with the copying (or not) of Apple's designs. The lawsuits have simply been a convenient (if expensive and risky) way to attempt to quash a threat that is of Apple's own making. While there's no doubt that Google has played a key role in Samsung's success by handing out a free mobile operating system to pretty much anyone who wants to build one — it is actually Apple, more than any other company, that is responsible for Samsung's present success.

    How? By outsourcing as much work to Samsung as they have. And it's impossible not to wonder whether Tim Cook's announcement yesterday on bringing back Apple's manufacturing to the USA is the beginnings of an attempt to rectify the problem.

    But first, I want to establish why copying is actually less of a threat to Apple than you might think. Daring Fireball's John Gruber wrote last year on what he termed "The New Apple Advantage". Like most people who appreciate Apple and its products, the starting point for Gruber's appreciation of Apple is its design — he says as much in the article. But the realization that Gruber has in the article on Apple's true competitive advantage is what's really interesting:

    So let’s be lazy for a second here, and attribute all of Apple’s success over the past 15 years to two men: Steve Jobs and Tim Cook. We’ll give Jobs the credit for the adjectives beautiful, elegant, innovative, and fun. We’ll give Cook the credit for the adjectives affordable, reliable, available, and profitable. Jobs designs them, Cook makes them and sells them.

    It’s the Jobs side of the equation that Apple’s rivals — phone, tablet, laptop, whatever — are able to copy. Thus the patents and the lawsuits. Design is copyable. But the Cook side of things — Apple’s economy of scale advantage — cannot be copied by any company with a complex product lineup. How could Dell, for example, possibly copy Apple’s operations when they currently classify “Design & Performance” and “Thin & Powerful” as separate laptop categories?

    This realization sort of snuck up on me. I’ve always been interested in Apple’s products because of their superior design; the business side of the company was never of as much interest. But at this point, it seems clear to me that however superior Apple’s design is, it’s their business and operations strength — the Cook side of the equation — that is furthest ahead of their competition, and the more sustainable advantage. It cannot be copied without going through the same sort of decade-long process that Apple went through.
    (emphasis mine)

    The argument is beautifully made. The design part of Apple's equation is to their ability to redefine new industries as they did with the iPhone. Whether they go after the TV market next, or something else, it's this integrated design component that will be crucial to their initial success. But compared to the business side of Apple, design actually generates much less sustained strategic advantage in any one product category, once performance in that category becomes "good enough". The tech industry has always revolved around copying. Once folks work out how it's done, everyone piles on. And at that point, it becomes much less about design than it does about how you operate your business.

    It is the last part of the Gruber quote that really drives things home. "It cannot be copied without going through the same sort of decade-long process that Apple went through". He's right — it's very hard for a competitor to outright replicate what Apple has achieved without going through all the same steps. But it got me thinking of a concept — and a related story — that I learned from someone I was fortunate enough to have as a teacher: Clayton Christensen. Perhaps a competitor didn't have to copy Apple.

    What happens if Apple had already taught them?

    Christensen first wrote about the dangers of outsourcing in The Innovator's Solution, explaining how seeking to maximize efficiency by employing third party vendors to do the "low value-add" work for you can be a lethal strategy. In the Solution, Christensen and Michael Raynor gave the example of two fictional corporations—"Component Corporation" and "Texas Computer Corporation". I had the good fortune to work with Clay on his most recent book, How Will You Measure Your Life?, and we recount a similar story; only without any of the players being disguised. The story is that of Asus and Dell, and how by outsourcing its work—starting with just basic circuit boards—Dell equipped a competitor:

    Asus came to Dell and said, “We’ve done a good job fabricating these motherboards for you. Why don’t you let us assemble the whole computer for you, too? Assembling those products is not what’s made you successful. We can take all the remaining manufacturing assets off your balance sheet, and we can do it all for 20 percent less.”

    The Dell analysts realized that this, too, was a win- win...

    That process continued as Dell outsourced the management of its supply chain, and then the design of its computers themselves. Dell essentially outsourced everything inside its personal-computer business—everything except its brand— to Asus. Dell’s Return on Net Assets became very high, as it had very few assets left in the consumer part of its business.

    Then, in 2005, Asus announced the creation of its own brand of computers. In this Greek-tragedy tale, Asus had taken everything it had learned from Dell and applied it for itself. It started at the simplest of activities in the value chain, then, decision by decision, every time that Dell outsourced the next lowest-value-adding of the remaining activities in its business, Asus added a higher value-adding activity to its business.

    There are two sides to this story: the part that relates to Dell, and the part that relates to Asus. Dell, in its quest to maximize its financial efficiency, continued to outsource way beyond manufacturing components and assembly. They outsourced a long way up the value chain. But there's also the side of the story that relates to Asus — a small components manufacturer that was, in effect, nursed to success by Dell. The extent of the schooling delivered by Dell to Asus was pretty profound, given how far up the value chain Dell outsourced its operations.

    But here's a question: at what point did Dell seal its fate? When was it that Dell had outsourced enough that Asus, with a desire to simply get out of the low-value work, could have made it all the way to the point that it did? I'm beginning to wonder whether just component development and assembly was enough. In the case of Samsung, it seems that everything else they needed to learn, they did by entering the emerging market, which Apple has largely left alone.

    Now, it's obvious that there are some very clear differences between the decisions that Apple have made in terms of outsourcing, and the decisions Dell have made. Dell outsourced its business all the way up to the design of its products. In many respects, Apple is doing the opposite — going so far as to even bring chip design in house. Horace has done some fantastic work detailing the extensive amount of investment Apple has made in its supply chain and it's clear that they've spent a lot of money investing in equipment used in production.

    But there's also no denying that Apple has begun to rely extensively on a network of suppliers across Asia.

    It's when you start putting the two arguments together that you realize that Apple may have a more serious problem on its hands. I want to again recount the final two lines of Gruber's argument:

    It’s their business and operations strength — the Cook side of the equation — that is furthest ahead of their competition, and the more sustainable advantage. It cannot be copied without going through the same sort of decade-long process that Apple went through.

    He's right — generating that scale requires a long gestation period — one that Apple went through. And it can't be copied without significant time and effort on the part of a competitor. But there's one big implicit assumption here — that suppliers won't turn around and start developing their own offering. Because when Apple went through this transformative process, where the design whittled down the broad range of offerings to just a few, and they generated the scale on the business side that accompanied that — they weren't actually the only one to go through that process. Apple's partners — their suppliers — went through it with them. And they've got very big, and very good at what they do. Samsung, obviously, is among those partners.

    Now, the response I often hear to this line of reasoning is: Apple hasn't outsourced anywhere near as much as Dell has. How are the situations analogous? But I think it's actually the wrong question. Instead, the question is: has Apple already outsourced too much?

    For all intents and purposes, we're at a level of maturity in the smartphone market where I believe design — particularly on the hardware side — has largely become commoditised. Performance is now "good enough". Whereas it was not so long ago that consumers sat on the edge of their seats to find out what the new iPhone had to offer ("please, fix the battery life", or "please, make it faster") the recent release of the iPhone 5 seemed not to generate the same intense reaction. Now, I'm not saying it won't sell well — in fact, it will probably become the best selling phone of all time — but people aren't making these decisions based on huge design differences between the devices. The basis of competition has shifted. HTC recently learned this the hard way when it introduced the One X — a phone that, to the critics, at least, was considered the best Android phone available — "a masterpiece",  "one of the best mobile devices I've ever used". Yet it has been absolutely crushed in the marketplace by Samsung.  How? Well, Samsung used its business scale to, as Horace put it on Twitter, "invite operators to a better party with an eye-watering marketing budget". This has nothing to do with Samsung making a better phone (they probably didn't), or Samsung copying Apple (indeed, HTC may have just done a better job of copying Apple). Instead, it has everything to do with the fact that Samsung has had its business sucked along in Apple's slipstream.

    There's another way of seeing just how deep the problem lies. Jobs promised "thermonuclear war" on the copied devices, and so far, the biggest target of Apple's many legal warheads has undoubtedly been Samsung. Getting a $1 billion judgement certainly proves Apple was serious about it. But doesn't it seem strange to you that the target of such a devastating strategy on the legal side, just so happens to be… one of the most important suppliers for Apple's new phone?

    The problem that Apple is facing right now has nothing to do with their designs being copied. There is a long history of copying in the tech industry; patents being deployed in lawsuits by giants often signify desperation more than anything else. Rather, the problem that Apple faces is that it now is going up against at least one competitor that has been a beneficiary of the scale that Apple has achieved on the business side. Samsung has clearly demonstrated that, like Asus, it was not satisfied being a low-margin ODM — of doing all the menial work while somebody else made the big bucks. Suing Samsung over Android patents isn't going to change that — if Google's operating system gets too expensive to use, there'll be a switch made to Microsoft. Or to another operating system altogether. It doesn't really matter, because design in the smartphone space has been commoditized. It's good enough. Manufacturers are now creating performance that most consumers aren't able to absorb. Instead, as we've moved into a world where performance is now "good enough", the world has flipped into one where it's the business side — operational scale — that matters most.

    Apple have taken steps to minimize the ability of competitors to duplicate their business advantage. There's a great post here on Quora describing how Apple has used its supply chain as a competitive advantage and how competitors end up subsidizing Apple's use of the technology. But the approach of "locking in" key new technology so nobody else can get them works best in a world where consumers need more performance from their devices — a world is rapidly slipping away.

    So, what's Apple got to do? In so much as it is able to trust its suppliers of key components not to become competitors, it can continue to use them. But where it can't, or where those suppliers have already become competitors, it has only one sensible choice — replace them. It has two choices here: the first (and obvious one) is with another supplier. But that risks the same thing happening all over again — Apple nursing another supplier into a competitor. The second choice: for components and services that are critical to maintaining competitive advantage in the markets which Apple plays, Apple needs to build the components themselves.

    Most companies wouldn't be in a position do that. But Apple is almost already there. I also hear that there might be a country out there with relatively high unemployment rate, looking for some jobs to be brought back home. Funnily enough, it seems that's just what Tim Cook is doing right now. This approach might just be a good way of on-shoring some of those untaxed offshore profits (I imagine the tax benefits for building a few factories in the US would be quite high), all the while taking away business from competitors — both current and future.

    But there's one question that still remains. In the instance of the threat that Samsung poses to Apple: is it already too late?

    –

    Looking for more information on the renaissance of production and its effect on the technology industries? Then come to Asymconf and take part in the debate.

     

  9. Apple's new factories

    Research · 87 comments

    Two years ago, almost to the day, I wrote a post titled It’s time for Apple to look at owning factories again.

    What I argued then was that of the problems that Apple had the means to fix, production was what most needed fixing.

    Since then we've seen evidence of significant investment in manufacturing tooling, where Apple is effectively purchasing the means of production rather than just renting or contracting it out. This capital equipment investment is the equivalent of owning one of the three asset classes that make up a manufacturing operation:

    1. Tooling or capital equipment. The "Capital" at the root of the concept of "Capitalism".
    2. Skills, talent and knowledge. This is the softer kind of asset that turns out to be harder to replace or buy.
    3. Labor pool. Although considered a commodity even unskilled labor is difficult to obtain if flexible employment is needed in a regulated environment.

    It did not stop there. It has also used capital to ensure capacity through pre-orders thereby allowing the skills and labor to be more predictably applied by its suppliers (and preventing competitors from having sufficient supplies). Apple has also taken control of chip design for the vast majority of its CPUs thus building a more bespoke supplier chain.

    However these are not enough steps to make production "good enough" to meet the demands of a billion customers buying a new product every other year.

    An insidious problem emerges when outsourcing:  suppliers tend to become competitors. It happened in the PC industry with Acer vs. Dell. But it's also happening to Apple. Consider how Samsung's foreknowledge of Apple's orders allowed them to anticipate the demand for large screen smartphones. Receiving orders years in advance for memory, screens and CPUs in the hundreds of millions would be a clear indication of demand. Receiving funds with which to build capacity is an enormous help when turning on production for your own versions of the product.

    With that knowledge and the capacity built to serve Apple, Samsung was able to go from near zero market share in smartphones to being the largest vendor in two years a feat that Apple itself could not accomplish.

    The supplier-turned-competitor is one of the risks of outsourcing production and is at the root of disruption from value chain evolution.

    Hence it's gratifying to see that Apple has committed to "in-sourcing" assembly of at least one product. Tim Cook in an interview with Rock Center:

    And next year we are going to bring some production to the U.S. on the Mac. We’ve been working on this for a long time, and we were getting closer to it. It will happen in 2013. We’re really proud of it. We could have quickly maybe done just assembly, but it’s broader because we wanted to do something more substantial. So we’ll literally invest over $100 million. This doesn’t mean that Apple will do it ourselves, but we’ll be working with people, and we’ll be investing our money.

    For the first time since the 90s, Apple is taking steps to control the last pieces of the value chain it participates in.

    It's a baby step and perhaps it's going to remain symbolic, but one can imagine a trajectory for this effort which will pay off as well as retail has paid off ten years after the first Apple store opened.

    –

    Looking for more information on the renaissance of production and its effect on the technology industries? Then come to Asymconf and take part in the debate.

  10. The policymaker's dilemma

    Research · 33 comments

    Here is an exchange with Robert van Apeldoorn, Journalist with Trends Tendances Magazine in Belgium. (www.trends.be/fr). The exchange took place in early September via e-mail.

    Robert: -Information and Communications Technology (ICT) is considered in Europe as a way to push growth, and is a target of national and EU policies (digital growth,etc), but the result seems to be a failure: the European computer industry (hardware) is almost dead (ICL, Siemens computers bought by Fujitsu, Olivetti almost out of computer business, Nixdorf dead) since the 90’, and the telco industry seems to be in crisis. All European companies are out of the handset business (big and fading exception is Nokia, but with  American software), and Alcatel is suffering with telco equipement manufacturing. It seems that at best, Europe can be a good niche player, with companies like ARM (chips). Technology seems to be reduced to localized services (computer services), some software businesses. What do you thing about that point of view? Is it correct or exaggerated ?
    What will remain to the European companies ?

    The main problem is perphaps the creation of European platform/ecosystems. Almost all are American today: Apple IOS-iTunes, Android, Amazon,…

    Why Symbian didn’t succeed as a competitive platform ?

    Is it possible to create European platforms? After all, IOS succeed after a short period of time.

    What are the European tech companies that could play an important role in the near future ?

    My answer: You are correct in this observation. Europe has failed to generate growth on the basis of ICT. The reasons are that the rate of change in ICT is rapid and getting more so. If European businesses require intervention, support or other forms of assistance in terms of policy, the time for that coordination to take effect is longer than the cycle time of disruption.

    Almost all growth has come from companies that entered the space. Google, Amazon, Apple and Facebook and even Microsoft came into positions of power from outside the industries they entered. Policy tends to offer means of sustaining incumbents or finding "logical" or defensible entrants. I should mention that the problem of industrial policy failing is not unique to Europe. Japan and to a lesser degree Korea are also facing crises of innovation due to policies designed to sustain rather than disrupt.

    It's understandable given the need to justify spending other people's money. No policy maker wants to spend it recklessly. However, the process of unforeseen growth is, well, unforeseeable. It cannot be predicted and it's very likely to come from somewhere other than where you expect it.

    This quickly becomes a lengthy discussion, but fundamentally the innovation process is chaotic. It's very similar to the process of artistic creation. The crisis in innovation comes from not having sufficient chaos. If Europe wants to preserve, sustain, nurture, and maintain it will do so at the expense of creative destruction. Nobody likes chaos but everybody wants innovation. Unfortunately they are concurrent things.

    thank you very much for these interesting answer. Usually the answer is the lack of venture capital or the compartimented market.

    So Nokia was an exception ?

    If a lack of venture capital is the problem then what is the cause of a lack of venture capital? There is plenty of capital on the continent. Why should it not be allocated to ventures? Capital markets in Europe are quite free and liquid and capital will find the best opportunities. The problem is that there are few fundable opportunities.

    I think Nokia was not an exception in the sense that it was not a "managed" success. The company (and Finland) emerged from a crisis in the early 90s. The crisis forced a re-evaluation of priorities and the success of Nokia could be attributed to a lack of emphasis in what was considered sustaining at the time (consumer electronics, TVs, natural resources, etc.) Entry into mobile phones was not what policy would have suggested was the biggest opportunity at the time. The market for mobile phones was projected to be insignificant in comparison to what was seen as success of the time (Sony, et. al.)

    [Addendum: What are policy makers suggesting as the key investment themes? Which projects get funding today and which don't?]