hardware

When a prosperous company buys a struggling company you have to wonder what they're really buying.

Here's how to think about it. A company is defined as the sum of three values: resources, processes and priorities (RPP). Everything of value can be classified into these three categories.

When one company buys another it's the equivalent of one set of RPPs trying to engulf or swallow another set of RPPs. The simplest (naïve) interpretation is that an acquisition is the purchase of Resources in terms of customers, sales, profits, etc. It might be of assets like employees, intellectual properties, brand etc. I say this is naïve because Resources are the easiest to value because they can be measured and valuing only what can be measured while ignoring what can't be measured is deeply mis-pricing.

So most people look for the "R" value or the value of Resources in an acquisition. It's may be naïve but it is what markets typically value because it's what they can price. But what happens when the "R" is flimsy or fleeting?

The answer has to be that it's  the processes or even priorities which are valued by the acquirer.

These are difficult to value which, as I've argued in The Innovator's Curse, is why they are not reflected in a share's price. When there is a price paid for these fuzzy assets, they are often interpreted as a "premium" to the market price. But that may not be the way a buyer sees it.

When buying a set of Processes, a buyer may see a bargain because their costs for building a similar process could be enormous, even infinite. In the case of Nokia, the process of building hardware may be infinitely valuable to Microsoft as they have had dreadful luck doing it themselves. But they're seen as value free to the market because it seems that there are many others who are building hardware.

The trickiest thing to perceive though is the value of a set of Priorities. Priorities are the answers to the "Why" question as much as Resources are the answers to the "What" and processes are to the "How." If you were to think in terms of software engineering Priorities are the "Specifications" where the Resources are the data and Processes are the algorithms. They determine the direction and reasoning of why a company even exists. If you have bad specs, it never matters whether the algorithm is efficient and you have all the data: you are building the wrong thing.

Acquiring Priorities is also fundamental in that they are usually exclusive. A company typically only has room for one set. If there are conflicting priorities, they need to be sorted out else the company can end up in a state of internal conflict and dysfunction. So if you're acquiring a set of Priorities, it's likely that you'll have to discard your own. It makes most sense when a company which might otherwise be prosperous needs to change direction.

So, in a way, an acquisition of Priorities is almost a reverse acquisition. The acquired is actually "buying" the acquirer. The acquired company's Priorities (and hence Processes and Resources) become the guiding principles in the acquirer. It's what happened when Apple bought NeXT and may have happened when Disney bought Pixar.

Some companies are "Resource-heavy", some are "Process-heavy" and some are "Priority-heavy". Great companies tend to have great sense of priority. They may also have greatness in the other asset classes but it's rare to find a great company without a great sense of purpose.

So the question for the Microsoft Nokia deal is what is Microsoft buying?

Resources? Sure, there is IP and a team. But the chances are that not all the team members will be kept on. See what happened to Motorola after it was acquired by Google.

Processes? Absolutely. Microsoft needs device development processes desperately.  They may seem a commodity but it turns out that running great hardware businesses is hard, very hard.

Priorities? Here we have to pause. To acquire Nokia's priorities means acquiring its business model; its belief system. Perhaps they will be discarded and they're not valued. Perhaps, as is often the case, the acquirer becomes allergic to the new priorities.

But Microsoft has made it clear that they are now a "Devices and Services" company. As much as Apple changed its name to exclude "Computer," Microsoft is almost changing its name to exclude "software". It will still make software, to be sure, but for it to get paid it needs to integrate that software into hardware and services.

My first thought on this is that Nokia's priorities are not sufficient for the company that Microsoft wants and needs to become, but there are some priorities which are necessary and which it values.

It may be too much to say that with respect to Priorities, Nokia acquired Microsoft, but insofar as Microsoft is having to transform its business model, what Nokia devices brings is an integral component of the new.

 

In the Innovator's Curse I reflected on the fact that a serial innovator cannot be efficiently financed or even rewarded for having figured out how to repeatably create. If anything, a serial innovator has to suffer a discount to peers who do not habitually (or ever) innovate. The innovation process is the proverbial goose that lays the golden eggs but is destined to perish due to the lack of faith in its existence.

So how can I back this up?

To start, this is partially evidenced in this graph of Apple's price to earnings ratio since 2006 vs. the S&P 500's. The S&P reflects the 500 largest companies in the US and is thus a proxy for the "average" company.

[I added Apple's P/E excluding cash for additional perspective.]

The graph shows that during the period of time when iPhone and iPad changed computing and telecommunications, Apple was mostly held in contempt: the profits it was generating were not considered of "sufficient quality" relative to an average company. Since markets look forward, not backward (one assumes), the vote cast is decidedly that success cannot be repeated. Put another way: you can trust that a soft drink maker like Coca Cola (P/E of 19) or a utility like ConEd (P/E of 18) will continue in the manner we've seen them perform in the last year more than Apple (P/E of 12) will.

I can offer yet another way to consider this curse. Apple's iOS business is designed to capture profits through the sale of hardware. That hardware is manufactured through a process where, while not being the manufacturer, Apple purchases tooling in a capital-intesive strategy to control the means of production.  I've discussed this at length before.

But Apple's business is more complex than just enabling manufacturing. Tooling allows for production and production allows for supply but supply is nothing without demand. And demand of the product is driven by investments in software and services and design and marketing and countless details.

In other words, for Apple's modus operandi, if anything should correlate with value it's opex, not capex. It's the investment in the people Apple employs not in the tools it buys.

And yet consider this graph:

It shows how the market (though its pricing of Apple shares) values the company overlaid with a Apple's spending on capital equipment (PP&E capex).

The relationship is uncanny. I'm not suggesting causality—that capex (which is publicly pre-announced) determines the share price level—but I am suggesting that there is a valuing of Apple as a producer of goods (for which tooling is a handy proxy). There is no sophistication to this formula. The more iPhones are built, the more the company is valued. Obvious.[1]

But it's not obvious that prior to the iPhone there was iPod, which was a different business (and prior to it was the Mac, ditto.) The stock did not reflect the transitions nor does it assume that anything else will follow. It is, in other words, looking backward, not forward.

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Notes:

1. One could suggest looking at CapEx months in advance and predict the stock price, but who would believe such an absurd idea?

Nokia's Windows (Smart)Phone performance was drowned out last week by Microsoft's big announcement of the Surface inventory write-off. They are pieces of the same puzzle however.

First, a look at Nokia.

There were 7.4 million Lumia phones sold in Q2 with 0.5 million sold in the US. Although Windows Phones grew sequentially from 5.6 million the previous quarter, and up from 4.0 million in the same quarter last year, total smartphones are down y/y and nearly flat over the last four quarters. This is of course because Symbian phones have finally disappeared from volume shipments. The following graph shows the history of Nokia's smartphone shipments.

Although it's tempting to compare Lumia to iPhone (given the premium positioning in the US) the average price of €157 or $206 shows that Lumia is more adequately compared to Android. This is about a third of what Apple gets for its iPhones.

That's not necessarily a bad thing. Nokia's always had a knack for mass-market phones and certainly that was one reason Microsoft was attracted to them. Presumably, the promise of the relationship was to insert Windows Phone into the Nokia development and distribution pipeline, squeezing out costs and filling up channels.

The problem for the brand has been that although priced at Android levels, volumes are nowhere near and the gap is widening. At current activation rates, Android is selling 16.5x faster than Windows Phone (assuming 90% of Windows Phones are Lumia).

So Nokia's problems become Microsoft's problems. As bad as Nokia seems to be doing with Lumia, it's doing a lot better than Microsoft with hardware. Here the story of the great Surface write-off should give pause. Microsoft announced that it would write off $900 million of Surface.  In terms of write-offs this is pretty significant. Compare it with the debacle of the PlayBook write-off when BlackBerry (then known as RIM) wrote off $485 million for tablets it could not sell. Or with Microsoft's own write-off for the Kin which took $240 million out of its shareholder's pockets. The only charge for hardware that I found higher was Microsoft's own Xbox 360 which cost it $1 billion for the "red ring of death".

But this is not an unusual situation at Microsoft. Besides Xbox, Kin and Surface, Microsoft also declared victory in (read: shut down) SPOT watches, the Smart Display, Tablet PCs and the Zune. This is why when I heard about the Surface I asked who would be Microsoft's Tim Cook.

By the way, $900 million write-off could amount to over 3 million devices, more if Microsoft is assuming some residual value in the inventory. Misjudging demand to such a degree that more units are disposed of than sold implies a basic failure of understanding of hardware businesses.

Which brings up the question of what Microsoft will do. They are likely to double down on hardware (also signaled by their re-org) simply because in a device world (read: post-PC) the economics of licensing Windows and Office are evaporating. The price points of EULAs simply don't hold and there are good enough alternatives in use by the hundreds of millions of iOS and Android devices out there already. By withholding Office from iOS and Android, Microsoft has shown a billion people that they can live without it and they already knew they could live without Windows.

So rather than fight, Microsoft chose to switch. Switching from software to hardware, however, is proving very hard. I'm sure quite a bit harder than management  thought.

I expected Apple's margins to improve  last quarter. They didn't and so the question I needed to answer is why. Here is a history of Apple's gross margin and operating margin as reported since late 2005:

For a company selling hardware these are extraordinarily high margins. They are higher than those of Google and have narrowed the gap with Microsoft,  neither of which has a high proportion of hardware sales:

But they are not growing and the reason is to be found in the reason they grew in the first place: because of proportion of iPhones making up the total sales.

As a reminder, the iPhone is a uniquely profitable product. I estimate that it obtains about 50% gross margins. The history of these estimates is shown below:

It remains in stark contrast to the margins Apple obtains for its other products. Much of that is due to the pricing power of the product as shown below:

Notice that even after the launch of the iPhone 5 and the persistence of two previous generations of iPhones (and their lowered pricing) has barely put pressure on pricing.

Contrast that with the iPad. As its breadth of offerings increases, it causes a lower price per unit.  The iPhone is now at $613 per unit, even with two older generation products available. (The lowest price was in Q2 2012 when the average price was $608.) The iPad is at $449 per unit, down from $662 at launch three years earlier.

So overall, margin is a function of three things:

1. Price changes: iPhone had a small reduction (from $635 to $613) but the iPad has had a moderate reduction in price (from $531 to $449).
2. Cost of components: This is reflected in product-line gross margins which can only be estimated. Compared to last year I estimate that iPhone gross margin dropped from 58% to 48%. iPad margins also fell from about 38% to 27%. The reasons were given by management as "Last year, our business benefited from …a more favorable foreign currency environment, and historically low costs."
3. Mix of high and low margin products. The iPhone units grew at 7% but the iPad units grew by 65%. A year ago iPhones were 58% of revenues and this year they were 53%. The iPads were 17% and now they are 20%.

The result is seen in this one graph showing the allocation of revenues and margins by product:

 

So what is surprising? My expectations were met in terms of iPhone units (and exceeded in terms of iPad units). The mix was also something that falls out of the unit expectations. The pricing is also not  surprising.

My guess is that the largest contribution to the "reduction of margin" is the increased cost of components. Note that the graph implies that even though iPhone revenues were nearly flat at 3% growth, the cost of those revenues went up by 29%! In addition, the iPad revenues grew 40% while costs went up 65%.

Unit pricing (and implicitly competitive pressure) is still not the primary cause of the reduction in Apple's margins. Indeed, the curious thing is that margins are now at levels seen for most of 2009 and 2010, a time when the iPhone (and iPad) were seen as near monopolies in their respective categories.

Google announced its first computing product: the Pixel. It's not the first Chromebook but it is the first device which is uniquely branded as a Google product (Motorola notwithstanding.)

It's a curious choice given that companies which have "crossed-over" from being service or software oriented to hardware have started with more "mobile" devices. Amazon launched the Kindle as a low-end product and gradually moved it up-market. Microsoft launched with the Surface tablet and then followed with the Pro version as a hybrid laptop/tablet.

It's also curious since Google has spent years contributing to the development of mobile phones and tablets under the Nexus sub-brand. This was an approach consistent with earlier Chromebooks as well.

But the Pixel is a high-end product. It's priced at the top of the range of what a laptop computer might cost (given the dimensions).  Perhaps it's part of a pattern where Google will hone its hardware skills toward releasing a phone or tablet it can call its own. Starting with a more traditional computer is "easier" than trying to deliver on the more demanding smaller form factors.

And yet, the more obvious question is why would Google want to be in the hardware business? Isn't being a web-focused company implicitly suggesting that hardware is a commodity to be farmed off to perpetually impoverished and violently abused OEMs?

The truth is quite different from this. Samsung currently makes far more operating profit from Android phones than Google does from all its operations. 

When looking at the patterns of sales and profit capture for hardware vendors since 2007 the contrast is stark:

Apple and Samsung tower over the fortunes for software only Microsoft or service-oriented Google and Amazon. Although all companies are growing, the value, as defined by the buyer, resides in the whole product. Putting aside all the theory, the numbers are staggering. Google, Microsoft and Amazon are skimming profits but they are not particularly efficient at profit generation vis-a-vis the integrated Apple (and increasingly integrated Samsung.)

The question is which of the companies illustrated above will prosper from the value chain evolution under way?

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.

Early data shows that the PC market has not experienced a "pop" from Windows 8. Market watchers have been anticipating this pop since every previous version of Windows has led to a surge in shipments. PC vendors have also been hoping for this to lift their volumes. Volumes have been stagnant for a while, as the following chart shows:

If we combine the traditional PC and tablet markets—what I refer to as "large and medium screen PCs"— there has been growth. However the growth is all due to the tablets. When seen in a share split (blue tablets vs. brown Windows PC's) the shift toward tablet computing is clear.

The question is whether Microsoft will be successful in shifting to this new computing model? Microsoft's problem is not that it has difficulty offering an operating system for tablets. The problem is that the economics of both systems and application software on tablets is destructive to its margins.

A PC has for several decades been "taxed"[1] with a Windows and Office license. The exact figure is imprecise because of subscription accounting used by Microsoft, but we can take Microsoft revenues for Windows and Office and divide by PC shipments to get an average.

This view shows how Windows revenues per PC have held steady for the last three years and Office have moved up slightly. In the latest quarter Windows "captured" $52 per PC shipment and Office "captured" $67.

The problem for Microsoft is that pricing systems software at $50 and a suite of apps at $67 for a tablet that costs $200 to the end-user is prohibitive.

Firstly because an OEM could not justify paying $50 to Microsoft while competing with another vendor whose (Android) software license costs nothing. It implies an increase in his bill of materials without the ability to charge more for the product and hence a reduction or elimination of margin.

Secondly because consumers (or IT buyers) would have a hard time justifying $67 for an Office license for every tablet when most apps are either free or under $10. (Apple charges $9.99 each for iOS versions of Pages, Numbers and Keynote which can be installed on several devices.)

The economics of tablets imply a "commoditization" of system and application software. So what's Microsoft to do?

The answer is Surface where the software margin is captured in hardware. This explains the pricing of Surface. The price isn't significantly below what Apple charges because Microsoft wants to capture a comparable (30%+) margin. On a $500 product that amounts to $150. After subtracting hardware operating and distribution costs we can get pretty close to the $120 it currently obtains from a PC.

This also explains the lack of appetite for "partnerships". OEMs which would normally compete on hardware would have to deal with zero margins (or less) after license fees and would be encouraged to cut corners and shave costs, compromising the experience and causing the platform to suffer.

Microsoft does not like the phrase "post-PC" because it implies the end of its hegemony. They like to think of the PC becoming a new form factor in which they have the same role they've always had. However, looking beyond the form factor we see that mobility itself is disruptive in the implied modularity of the PC.

Device economics offer the explanation for an otherwise perplexing Surface strategy. The question remains how many Surface units could Microsoft possibly sell to maintain its revenues.

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1. A "tax" is implied only when purchases are mandatory.

Tim Cook speaking about the Apple TV product:

For Q4 we sold 1.3 million. That is up over a 100% year-on-year. We sold more than 5 million Apple TVs during the fiscal year, which is almost double the previous year, when we sold 2.8 million. So the business continues to do very well, but if you look at the size of revenue of this business versus our other businesses, it’s quite small and so it still has the hobby label, however it’s a beloved hobby and we continue to focus on it and continue to believe there is something more there and continue to pull the string to see where it takes us.

Five million Apple TVs per year is a half-billion dollar hobby. As such it quintupled from the first year (calendar 2007).

The value for hardware is, of course, only a part of the story. It is accounted for as part of peripherals revenue and amounts to 18% of total peripherals revenues. Last May I estimated that the installed base of Apple TVs was 10 million. I'd estimate current total to be closer to 12 million. Assuming $10/month in content sales per Apple TV results in $1.4 billion of which 30% might be retained by Apple as revenue (agency fee).

The yearly revenue thus could be as high as $900 million. Therefore it seems plausible that Apple TV is on the verge of being a billion dollar business.

It may be a hobby to Apple but I've noted before on my podcast that Apple TV is a mirror image of the Kindle business model: Sell hardware at low margins and experiment with content sales as a profit model. The "hobby" moniker means that it's not a big business but how big is Kindle or Nexus 7 for their respective owners?

Kindle may sell up to 10 million units at nearly break-even but is the average revenue per user much higher than Apple TV? What about the Nexus franchise? Is the loss on hardware leading to revenue to Google+OEMs above $10/month? I doubt it.

I can't be precise or absolute about it since we don't have data from Amazon or Google about units or from any of the platforms' margins or attach rates for content, but I'm doubtful that they qualify for more than hobby status according to Apple's definition. At least in terms of profitability, Apple TV could be bigger than either Kindle or Nexus tablets.

It looks like the next iPhone will be called the iPhone 5. What's in a name? As it turns out, quite a lot.

Every hardware product that Apple has released has had a brand and a sub-brand. Macs for example use the Mac brand and a sub-brand as follows:

• iMac
• Mac Pro
• Mac mini
• MacBook

Thus each sub-brand imparts certain meaning to the buyer. i, Pro, mini, book are all evocative. MacBook even has its own sub-brands:

• MacBook Pro
• MacBook Air

These Mac sub-sub-brands of Pro and Air are specifically designed to also distinguish and convey meaning.

iPods as well use the iPod brand followed by a sub-brand.

• iPod Classic
• iPod touch
• iPod mini
• iPod shuffle
• iPod nano

Note how the mini  sub-brand was retired from the iPod line to be used exclusively in the Mac product line. That may not be specifically necessary or desirable but it is an interesting coincidence. (The Pro sub-brand is shared between different Mac lines)

However, when we look at the iPhone and the iPad, the nomenclature has been distinctly different. Both products have been using generational naming conventions. This implies no sub-branding as the iPhone and iPad are the only identifiers of brand and hence the only meaning being imparted to the buyer. You either get an iPhone or and old iPhone.

That changed with the iPad however. The third generation iPad became just iPad. This was deliberate (why would they want to confuse buyers?) I think there is some logic to this.

Note the parallel to the convention of the original iPod. When the iPod launched it was just the iPod. Subsequent versions were identified by a generation, but not a specific sub-brand. After the third generation iPod (still called iPod), the mini version was launched, creating the sub-brand convention that remains in use to this day. The iPod therefore was born generational but switched to sub-branding in adolescence.

The possibility exists, therefore, that there will be a sub-brand for the iPad. Perhaps "mini" is being reserved for a new iPad, to distinguish it from the regular iPad (no sub-brand) that is likely to remain in production. The logic is to make room for sub-brands when the core brand begins to cover a wider array of form factors, themselves proxies for separate use cases or jobs to be done.

So what about the iPhone?

The iPhone has remained, stubbornly, after five years, stuck with a generational naming convention vis-à-vis the sub-brand convention used in every other mature product line from Apple. (Note that software from Apple adheres strictly to a generational naming convention because there is no "room" for a sub-brand under a software brand. There can be no "iWork Pro" or "Final Cut EZ". [Update: there once was Final Cut Express])

Prior to today I entertained the possibility that the new iPhone will follow the iPad in dropping generational naming in favor of sub-branding thus implying that the brand would develop into a portfolio of sub-brands (like the iPad seems about to.)

Alas, that possibility now seems moot. The launch announcement seems to clearly point to "5" being the name of the new iPhone. The brand remains iPhone and there will be no sub-branding.

This can only mean that Apple intends to preserve a single product strategy for the brand. There will be no "special" iPhone for different (e.g. low-end) markets. There will be no different form factor to accommodate different use cases. There will be no new jobs to be done for the iPhone.

What a bummer.

However, there may be something more curious happening. Note all the service brands being launched on the iOS platform. There's Siri, (as yet unnamed) Maps, GameCenter and PassBook. These are not Apps. These are services designed to be unique to iOS, perhaps even unique to the iPhone. The difference with the iPhone brand may not be that it spans a multitude of sub-brands in hardware but that it covers a multitude of new service brands. As brands imply meaning, the iPhone brand may imply that it's a platform in and of itself.

Now that's an interesting development.

 

This interview was conducted with Bruno Ferrari Editor of Exame magazine in Brazil.

First, do you have forecasts for tablet market share including Microsoft for next years? (Apple, Android, Amazon etc)?

I have some guesses but I don't think it's something that is defensible. Too many things can change. Fundamentally I believe Microsoft sees the tablet as a PC and intends to migrate a substantial portion of would-be PC customers to tablet forms. If they are successful then they preserve the existing PC user base and allow it to grow a bit.

In contrast Apple sees the iPad as a new type of device that is used for things not directly related to PC style computing. In that sense the iPad competes with PC non-consumption. It means people may own both a PC and an iPad and some will own only an iPad. The iPad will expand the market while taking share from the PC. Windows tablets will try to hold the Windows share steady.

 How do you analyze Microsoft’s strategy with Microsoft Surface? Don’t you think they’re admitting themselves that Apple was right since the beginning?

We don't know the strategy yet. Without pricing and an idea of how the other OEMs will respond, I have more questions than answers. The fact that they are doing their own PC hardware does indicate that they see the industry architecture changing and that a large number of vendors offering hardware "choice" is not really the basis of competition in PCs. In other words, buyers are not willing to pay a premium for Windows because the hardware it's available on is offered in a wide range of options.

Do you think MS growth at tablet market will surpass the lost at PC (desktop and notebook) market in the next years?

This is a crucial question. It's possible that Windows 8 on tablets will create new markets, like the iPad has done and it could take the leading role in expanding computing in a post-PC era. However, to do this, Windows 8 and its successors need to be optimized to solve the new jobs people may have for mobile devices. They have to do this even though they need to sustain the old use cases and business models. To succeed Microsoft needs to "fork" the business model and create new ways of profiting from hardware and software. The rumors that Windows 8 RT devices will be sold at a loss is perhaps a hint that this is the plan.

Did you see the rumor of a 199 dollars Surface? If it’s true, do you think is a good strategy?

It all depends on what will be the alternate source of revenue. I assume there will be some sort of subscription service, taking a page from the telecom industry. Perhaps a mixture of Windows Live services (media, documents in the cloud and software updates). We have to see whether subscription computing makes sense for consumers.

How do you see the problem that MS is creating with its OEM by turning itself on a tablet maker?

There is a problem, of course. However here again the question is whether they are moving to an "ecosystem subscription" model and whether they want to offer revenue share to OEMs. If they offer something then Microsoft plays the role of the operator and device makers are paid some up-front subsidy in exchange for keeping their systems locked into the network.

 One more questions: did you already estimate the shipments of Samsung Galaxy Tab since its launch?

Sorry, I don't have the Galaxy Tab estimate. However, here is what I found:

A week after its release, Samsung announced that they had sold 600,000 units. On the 4 December, it was reported that the 1 million mark was reached, two months after launch. However, an executive at Lenovo claimed that Samsung had only sold 20,000 out of the 1 million Galaxy Tabs that were shipped. In January 2011 Samsung announced they had shipped 2 million units to stores. In August 2012, actual sales figures were released in the patent infringement court case against Apple showing that a total of 725,000 Galaxy Tabs were sold through Q2 of 2012.

Source: Wikipedia.

Note that the figure of 725k is US only.

Thanks to Angel Lamuno for sending me to a dry and boring lecture by Dr. Israel Kirzner from Feburary 1988. It got me thinking again about competition and how confusing it can be.

The lecture was in part about how the word "competition" is used by economists with directly opposing meaning from that of the layman and how that leads to confusion about the role of free markets.

I won't dwell on that, but instead I want to explain how this word can also be contradictory in meaning when applied in everyday usage in business analysis. Nowhere is this more evident than when we argue whether Apple competes with X or Y or Z.

Does Apple compete with Android or Google or Samsung? How could Apple compete with Google and yet cause it to be the default search engine in Safari thus enriching their competitors? How could Apple compete with Samsung and yet select their semiconductors for the heart of its most important and profitable product? And how could the people across the table from Apple agree to terms on these deals while being sued by them?

Some have tried to characterize this situation as "coopetition" or the co-habitation of conflicting strategies for a balanced optimum. I find this characterization uncomfortable and unsatisfying. The balance sought will be very fragile and change daily and no optimization is practically possible. It seems contrived.

Rather, I think about these situations as examples of asymmetric competition. This is competition where companies are rivals but they have different definitions of the basis of competition. In a way, they are like gladiators who have weapons which cannot be brought to bear or wielded effectively to counter the opponent's.

Consider the following question: does the iPhone compete with the Galaxy SIII? Well, obviously it does. The products have similar attributes. If we define competition as rivalry in a market for similar products then, by default, they compete.

But what about non-consumption? What if there aren't enough of either product to go around and people cannot actually face a purchase decision where both products are in front of them at the same time, under identical terms and conditions, waiting for a purchase to be made.

It gets worse. What if there are network effects related to each product such as brand loyalty, platform switching costs, media and data tied to either one that make them impossible to switch? What if advertising spending is skewing the buyer's knowledge of competing products?

If a product is unavailable, invisible or requires burdensome switching, does it really compete? When these exceptions are raised, you'll hear people say that Apple (or Samsung) don't compete with X or Y. They compete with themselves or with products outside the category. There may be many ways of rationalizing that  what appear to be similar products don't compete because of "differentiation" or "positioning".

In fact, jobs-to-be-done theory suggests that the only successful competition is against non-consumption, especially if you're an entrant. Non-consumption is easy to beat (because the alternative is no solution to the job) while an entrenched incumbent is very difficult to beat, and it's often inefficient to even try even if you have the resources. This is what I describe in talks as the "David vs. Goliath" approach vis-à-vis the "Charge of the Light Brigade" approach.

So the theory that competition exists on the de-facto basis of a similar feature set fails a whole series of tests in the real world. Consumers decide based on complex criteria and businesses actually conspire to make the choices as complex as possible reducing the decision to a single option.

But I want to step back and think about the situation from the competitors' point of view. In other words, how should management think about competition? Is it possible to develop a competitive strategy or should one even bother with competitive response?

Let's take a basic question: Does Apple think of Samsung as a competitor? When did it begin to think about it as such? What can it do to win?

Let me answer this by asking another hypothetical question. Assume it's 2008 and Apple is in the process of planning its product roadmap. Whom would they decide to count as competitors? Android devices have not yet shipped and the gorilla in the space is the BlackBerry with Symbian still overhanging the market with a huge volume lead. Should they then build products to compete with RIM and Nokia?

Assume further that their decision will define how developers will build apps and content makers will target your product. They have to account for the time scales that developers think about and they have to match hardware innovation to the rate of OS innovation and API innovation and toolchain innovation, etc.

So did Apple consider Samsung a competitor in 2008? A time when Samsung did not actually make smartphones? It seems hard to believe they did. Now you may answer that things have changed since 2008 and they have. But the decisions made in 2008 regarding the platform remain in place today.

Furthermore if you happen to look at the dozens of hardware designs that are making the rounds today (as evidence for a trial with Samsung) you'll see familiar designs first penned in 2004 or 2006. You quickly realize that the product design process is lengthy and largely isolated from the froth of main street (or mall) sales fistfights.

Few people appreciate the disconnect between the design process and competition. This because few people have spent time in an organization building mass market consumer phones. The time scales are staggering. If your product is a platform product you make decisions six years in advance. If you are a "fast follower" you can make decisions six months in advance. This is maddening, asymmetric competition.

One competitor sees one basis of competition and another sees it completely differently or sees a completely different basis. They are competing with each other but more as a guerrilla fighter competes with a nuclear missile.

Which brings me to another discipline. In military circles asymmetry has been noted as a valid form of warfare for some time. At least since 1975. It was in use long before it was recognized or studied, (e.g. in the American Revolution.) But the situation now exists where it's taken for granted that modern conflicts are almost always asymmetric. Drones vs. insurgents and citizens vs. armor and, the most sinister of all, unarmed-but-tightly-integrated-through-communication protest against established regimes. The impact of this realization is affecting governments around the world.

So it's time to elevate our thinking about business competition along the same lines. Yes, Apple competes with Samsung but it does so asymmetrically (as it does against Google and dozens of others). It's a multi-dimensional rivalry and one which requires a different form of analysis. It is something which I do instinctively but it's not something that is easily explained. Disruption theory helps. It turns out that asymmetric competition is the only form of competition that matters in a rapidly disrupting industry.

It is also why this site is called Asymco.