software

The International Federation of the Phonographic Industry (IFPI) reported that global digital revenues were $5.6 billion in 2012. This represented about 9% growth from 2011 and accounted for 34% of total industry revenues[1].

Apple regularly reports iTunes as a separate revenue item and occasionally it also reports payments data for developers and app download rates. By interpolating the data published and combining it with some assumptions it's possible to estimate the mix of revenues (and costs) associated with iTunes.

My yearly estimates are summarized below.

Note that I also included historic digital music industry revenues (as a line). I also included the following summary items:

1. iTunes reported revenues were $13.5 billion (including Apple's own software sales)
2. iTunes gross revenues were about $15.6 billion (including payments to developers)
3. The iOS and OSX "App Economy" was about $7.5 billion while the iTunes "Media Economy" was about $8.1 billion (both figures include transaction costs.)
4. The iTunes Music economy was $4.3 billion of which $3.4b was paid to music labels.[2]

In terms of percent of total value the components are:

Looking at growth, these estimates imply that App revenues are growing at about 50% while iTunes Music is at 10% and Video+other at 90%.

Looking at profitability, there is potential for operating margin in Apple Software and App Agency Fees and perhaps some of the Media Transaction Fees (exploded wedges above). Historically, Apple suggested that their App and Media stores ran at break-even but that may no longer be the case. Operating margins from Software may be significant.

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Notes:

1. These revenues were from recorded music and don't include live performance
2. My estimate for the iTunes Music payments to publishers is equivalent to about 60% of total industry revenues.

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.

As Apple introduced a new set of revenue categories, the performance of its "minor" businesses has become clearer. The changes include re-statement of what used to be called "Software" revenues as part of iTunes. Apple Software includes sales of OS X, iWork and its pro tools. These products are now sold through the Mac App and since that is a part of iTunes its inclusion makes sense.

However, we have to understand that iTunes now is a blend of many business models. Some, like music, use a wholesale revenue recognition method and have very low to zero margins, others, like eBooks and Apps, are sold using an "agency" revenue model with potentially higher margins and some, like Software, are recognized at full value with very high margins.

When re-stated this way, iTunes becomes much more than a "break-even" business. My own estimate for its gross margin as currently reported is between 15% and 17% but it could be even higher. This allows the following picture to emerge:

These graphs show contributions to Revenue and Gross Margins of the various reported product categories. Note that restatements for Accessories and iTunes only extend back to Q4 2010 and the older "Software" is still shown for earlier periods.

Note also that Accessories are now including some of the revenue that used to be reported as part of iPad and iPhone revenues. This was discussed in more detail here.

There are several observations we can make:

1. iTunes now becomes a steadily and rapidly growing business. Growth over the previous two years averages well over 30% and is consistent across seasons.
2. The absolute revenue number is substantial: $13.5 billion for 2012 (up from $10.2 billion in 2011).
3. Assuming a gross margin of 15% to 17% yields contribution of $2 billion in margin in 2012 and $1.6 the year before.
4. iTunes is now Apple's fourth largest business, having overtaken the iPod in revenues two years ago
5. iTunes growth relative to the Mac means that it could become the third largest business during this year.

When seen this way, as a percent of total, iTunes begins to look increasingly as a viable "leg stool" upon which Apple rests. Note that in the following charts the percent of total for iTunes holds steady while Mac and iPod decline.

Adding the Accessories business (which includes Apple TV and is showing in Orange above) these "other" businesses are already bigger than the Mac. Of course, content, software, accessories and services depend on a healthy device business, but the size of these ancillaries are beginning to be substantial and Apple's ecosystem may begin to be valued more than just as an incentive to buy the devices.

Indeed, if seen in isolation, iTunes+Accessories combined is a bigger business in terms of revenues than any of the other phone vendors except Samsung:

 

We take on the future of TV again, given the developments and experiments hitting the news. Hanging in the air like a big matzah ball is the question of a catalyst to bring long form video to the age of software. Not just digital production and distribution but an integration of software into the product itself. We get there via a quick recap of Asymconf California.

via 5by5 | The Critical Path #72: Bingewatch.

Show Notes & Links

• Asymconf California 2013
• It’s a wrap. Asymconf California | asymco
• Apple’s Calendar Fourth Quarter 2012 Growth Scorecard | asymco
• Margin Call | asymco
• Daring Fireball Linked List: Should Apple Follow Netflix's Lead and Produce Its Own Movies and Shows?
• Netflix's Risky Strategy For 'House Of Cards' - Forbes
• Netflix to debut new 'Arrested Development' episodes in May | Internet & Media - CNET News
• "Arrested Development" Comes to Dive Into Media With Arnett, Hurwitz - Peter Kafka - Dive Into Media - AllThingsD
• Amazon’s Downton Abbey Coup: Bad News For Netflix - Corporate Intelligence - WSJ
• Arthouse Cowboy - Warner Archive Instant Begins Closed Beta Today
• Kevin Tsujihara Named CEO of Warner Bros. - The Hollywood Reporter
• Kevin Tsujihara - WarnerBros.com - The Studio
• Vigil received no bids and other details from the THQ courtroom proceedings | Polygon

I last looked at the race to a billion in March 2011. Since then, I've been updating and adding data to the set giving a broader selection of platforms to compare.

Before we dive in, an explanation: the initial review excluded Windows (PC) and Facebook mainly because (a)  the ramp scale I'm using is about a decade in duration and (b) I was reluctant to compare platforms that require payment to join to those that don't. The (DOS/Windows) PC ramped over several decades (starting in 1981) and Facebook is a service that costs nothing to join. There was much gnashing of teeth and shaking of fists as a result.

Therefore, in the interest of inclusion, I added both to the data set and let the chips fall where they may.

The data is shown below.

I kept the scale to about a decade so that individual lines can be resolved. As a result, you'll note that although Windows reached one billion first it did so slowly enough to be off the scale shown. Indeed, the "race to a billion" should be titled  "The race to one billion users in less than a decade".

In such a competition, the winner would be Facebook which, in October 2012, 35 quarters after launch, reached the finish line. The second looks to be Android (probably this year) and the third iOS (sometime next year.)

That may sound like the end of it, but what the graph also shows are the more subtle trends:

• Game consoles seem to saturate at below 100 million total. One can see the difference in ramps between recent mobile platforms and consoles in the second chart. There might be implications for which platforms will end up dominating the entertainment industry. There should also be some explanations of why consoles are so limited.
• iTunes accelerated with iOS and left the iPod behind. This is unsurprising but it shows that a content platform can be more flexible than one attached to any particular device or architecture. An important lesson perhaps for those in the content businesses.
• Early mobile platforms like Nokia's Symbian, RIM BlackBerry and Windows Mobile have faded indicating that there was no early-mover advantage in platforms. The same can be said for early PC platforms.
• Windows Phone began by tracking the Android/iOS ramps but seems not to be accelerating into its second year in a way that implies potential parity.
• Although Facebook did reach 1 billion rather quickly the slopes of Android and iOS indicate that they may overtake it in overall ecosystem size.

One billion is significant in several ways: First, because it is the "high-water mark" set by Windows and signifies what a global platform needs to become to be essentially "universal". Second, because it implies sustainability. A threshold perhaps from which network effects are sufficient to sustain (assuming some switching costs and an ability and willingness to adapt e.g. software, content or time investments from users.) Third, because it implies sufficient value to the ecosystem (assuming a monetization mechanism exists e.g. Windows software developers and IT managers.)

Looking beyond this milestone however, there is no reason why it should be thought of as a barrier. Mobile connections number over 5 billion and computing is likely to reach most of them. Therefore one billion may turn out to be only 20% penetration. In fact, I expect this series of posts will need to be updated in 2013 as "The race to two billion."

In 2011 Microsoft's CEO bemoaned that revenue in China was about 5% of what it obtained in the US. Yesterday Apple's CEO suggested that revenue from China will overtake the US in the near future.

The contrast is even more stark when one considers the time and effort each company has made in China. Microsoft has been investing and promoting itself in China for decades while Apple barely had any presence 3 years ago.

To put a finer point on this I show below Apple's sales by region:

Apple's China net sales in fiscal 2009 were only 769 million. In 2012 they were $22.8 billion. That is a figure greater than US sales three years earlier. Put another way, China sales grew in three years as much as they did in the US in 33.

The growth rates were astronomical: over 250% in 2010 and 350% in 2011. In 2012 the growth slowed to 83% but that is still almost twice the US or the global average. The growth rates are shown in the following chart:

I added an estimate for growth into the future moderating to 50% for China and 20% for the US. If that happens then China will become the largest market for Apple by 2016 as shown below.

The reason for this growth is, of course, the iOS product lines. Growth started when the iPhone was introduced and surged with the iPad and every time updates were released.

The contrast with Microsoft now comes back into focus. China and the US have a roughly equal number of PCs but the mobile users in China exceed the US by a factor of three to one. The pool of users is so great that Apple obtained its growth even with reaching only 30% mobile network distribution coverage.

Without a mobile portfolio Microsoft is severely hampered. Of course, Microsoft is trying and has made several attempts to place its Windows Phone in the hands of Chinese users. It's a tough sale however because Microsoft must work through partners. They need to get vendors to license the OS and the operators to range the devices and retailers to push it. Given the flood of "free" Android variants they are having trouble even starting down that long road.

But more fundamentally, Microsoft's software licensing business model is severely limited in China because what it offers is not what is valued. Both on the PC or on the mobile device, what China values is the tangible. Software can be made valuable only if it can affect the purchase decision of hardware and it can do so only if it's sold as part of an integrated product. With Surface, Microsoft shows that it understands this. What does this imply for a Microsoft phone?

 

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.

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?]

In the parlance of developers Apple keeps "throwing exceptions." This quarter the iPad surprised with a significant decline in sales growth. I placed a table showing the sales growth for this quarter as well as the previous 22 quarters at the bottom of this post.

Here is a quick review of each line:

1. The iPhone returned to a more customary growth rate (which I rate as Very Good--above 50%). The quarter was bound to be quirky due to it being both a transition quarter and a launch quarter. The launch of the iPhone 5 came quite late but not too late to make a contribution. It was also widely rumored and anticipated so there was slowing of the previous generation product. I expect growth to accelerate further in the last quarter of the year.
2. The Mac turned in a commendable 6% revenue growth (1% unit growth) on the back of the new 15" Retina screen MacBook. The average sales price increased sequentially and the mix of portables to desktops reached a new high of above 80%. More about the Mac will be written in a future post.
3. The iPod continued its decline. The 26% sales decline was in-line with other non-launch quarters. The company tipped its hand and let us know that iPod touch now makes up 60% of iPod volumes. At 3.2 million iPod touch units, it's a significant iOS contributor but still a declining number.
4. The iPad was painfully underperforming. With only 9% revenue growth, it was a complete reversal of the torrid growth of the last two years. Management blamed both anticipation of a new product and a reduction of inventory ahead of refresh of the larger screen retina. The only silver lining was that the average price decline was moderate (down about $3/unit). Overall, I'm very disappointed with the pause in the product but the new mini could change the character of the product dramatically in a way similar to how the iPod mini turbo-charged the iPod line.
5. iTunes had a very good quarter. It's the perennial growth engine with the most consistent performance throughout the time period shown. It was the second fastest growing line item firmly in the "High" growth bracket.
6. Peripherals, including Apple TV had a moderate quarter. Management revealed that about 5 million Apple TV units shipped in the fiscal year. That adds up to a half-billion dollar revenue business. Peripherals had $2.8 billion over the same time frame so Apple TV was about 18% on a yearly basis. This does not include content revenues.
7. Software had a modest growth of 22% but has come to be the high end of the range. Since changing the way it prices OS X updates, the era of Apple software windfalls is over. Still, at nearly $1 billion per quarter it's nice pocket change, especially as it's nearly all margin.
8. The overall top line (net sales) was a bit improved sequentially (+4 points of percent) but still in the "transition quarter" range of moderate growth. The company may be shifting its launch cycles and as a result we're seeing a break in pattern. As pricing for iPhone and iPad did not change very much the slowing of top line growth is entirely due to a unit shipment reduction. Again, the primary cause is transitions in multiple lines simultaneously.
9. The bottom line (earnings) followed the same pattern as top line (slight sequential increase in growth). There was a slight attenuation of margins (gross margins are down to 40%).

Overall, the quarter was not up to the recent level of performance for Apple. Growth was overall "moderate".

Marc Andreessen famously coined the phrase "software is eating the world." It's an apt observation. If you look back on the history of computing you're likely to measure computers sold or devices sold or users harvested or productivity gained. These things are measured because they can be measured. But the greatest cause of value created and captured has been the development of software. An ephemeral product whose value is often ignored in analytical discourse.

Software is not easily measured and it's not easily valued due to its intractable nature. Firstly, because businesses that make software tend to have weird cost structures--absurdly high fixed costs and operating margins: They operate without income for years and then suddenly are massively profitable with a minimal set of resources. They have a non-linear, "big bang" trajectory.

Secondly, software companies tend to capture revenues from something other than the direct sale of the good. Software is rarely sold. Services sometimes are sold on the basis of software but more likely audiences for services are sold to a set of bidders, or revenue is obtained in even more circuitous ways.

Thirdly, because there are curious multi-sided markets for software platforms. Charlie Kindel hints strongly at how difficult it is to understand the dynamics of software platforms. There is the prospect of lock-in of users and data. There are relationships to nurture with developers and there's the principle of an ecosystem that creates network effects. The virtuous/vicious cycles are non-linear and unpredictable even for the experts who have been at it for decades (e.g. Microsoft).

Given these difficulties, software is seldom seen as the core value proposition for a particular business. But make no mistake about it, Apple, Google, Microsoft, Facebook and Amazon are all software companies. They "monetize" or integrate software differently but software is causal to their profits. Their use of software has also made them all disruptive. Software enabled the disruption of consumer electronics, retail, computers, advertising and broadcast media.

But we have not seen anything yet. There is another class of software that is poised to lay waste to a new set of industries. The lowly app coupled with cloud-based services[1] is the termite that is set to eat the foundations of the largest of the industries still standing.

Consider the following:

• Games. A software industry in itself, the app versions are attracting non-consumers and eventually will get good enough to absorb all  usage and profits. Games merged with "entertainment" concepts will lead to new models of user recreation leading to new global brands that could challenge even Disney.
• TV. As apps come to the big screen TV will never be the same. Not only will show creators build directly for an audience but advertisers that currently sponsor shows will produce them instead and package the result as an app.
• Shopping/dining/entertainment/hospitality are changing with location services and with novel "bits to bricks" purchase options (e.g. PassBook). Increasingly services will exploit handheld devices to enable product discovery--the main job retailers are tasked with.
• Communications. The observation that "phone" is just an app and that messaging can be done in dozens of ways depending on message, relationship, context or even custom is possible because apps conform to the user's needs rather than the user conforming to the tools they get from the network service provider.

Although these are enormous opportunities in themselves, this is in addition to several industries that are already crumbling (photography, book publishing, to name two).

I don't need to rely on prose alone to make the point. A graph can also lend a hand.

Consider that Apple's App Store and Google Play together have had over 50 billion installs in less than four years and that the number of users of apps is at least 750 million. Furthermore, consider that apps have moved from a smartphone phenomenon to tablets and even PCs using OS X or Windows. Within one year these software capsules are going to be in use by one fourth of the global population.

Nothing has this kind of reach or engagement, not even browsers. What makes the app disruptive, even ahead of a browser-based service, is that it includes incentives for developers (or, more precisely, app producers) to get paid and to have a relationship with the buyer. These two value propositions, in isolation or in combination, are available to millions and consumable by billions. The most democratized market that can be imagined. An unbounded set of producers and an unbounded set of consumers and a persistent connection after the purchase with nothing in between them except a payment mechanism

The world has never seen such an opportunity.

The consequences are unforeseeable. Apps are a form of software that goes beyond its ancestral "application" as a product and as a business model. It's the software that will take in and assimilate everything in sight.

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Notes:

1. I have a simple rule to distinguish between an app and a service. If you have to supply a username and password to an app, it's a service.