Apple’s Organizational Crossroads

Apple is unique, and I mean that objectively.

Forget about products for a moment, about which reasonable people can disagree. Leave aside the financial results, which certainly are unprecedented. And ignore the people you know so well: folks like Jony Ive or Jeff Williams or Phil Schiller, and the many talented workers underneath them. Rather, the very structure of Apple the organization — the way all those workers align to create those products that drive those exceptional results — is distinct from nearly all its large company peers.

The Unitary Organizational Form

Apple employs what is known as a “unitary organizational form” — U-form for short — which is also known as a “functional organization.” In broad strokes, a U-form organization is organized around expertise, not products: in the case of Apple, that means design is one group (under Ive), product marketing is another (under Schiller), and operations a third (under Williams, who is also Chief Operating Officer). Other areas of expertise represented by the members of Apple’s executive team include Software Engineering (Craig Federighi), Hardware Engineering (Dan Riccio), and Hardware Technologies (Johny Srouji).

What is most striking about that list is what it does not include: the words iPhone, iPad, Mac, or Watch. Apple’s products instead cut across the organization in a way that enforces coordination amongst the various teams:

functional

The benefits of this approach are well-known at this point, and captured in the name itself: “unitary” is a synonym for “integrated”. CEO Tim Cook has repeatedly extolled Apple’s ability to create integrated products that deliver a superior user experience, and former CEO Steve Jobs made clear in one of his final keynotes that to do so required more than wishful thinking:

[iPads] are post-PC devices that need to be even more intuitive and easier to use than a PC, and where the software and the hardware and the applications need to be intertwined in an even more seamless way than they are on a PC. We think we have the right architecture not just in silicon, but in our organization, to build these kinds of products.

This is why the very first thing that Jobs did when he returned to Apple, even before he famously pared the product line down, was to reorganize the company functionally; then again, perhaps the distinction is meaningless — a functional organization and a simplified product line go hand-in-hand.

Why the Multi-Divisional Form Was Invented

Back in 2013 when Steve Ballmer reorganized Microsoft to be (somewhat more) functional, I criticized the move in a piece entitled Why Microsoft’s Reorganization is a Bad Idea;1 as an introduction I described how the “multi-divisional form” — M-form, or divisional organization — came about:

DuPont, the famous chemical company, was actually built on gunpowder. Founded in the early 1800s, DuPont was a small family concern until the early 1900s, when Pierre DuPont modernized and organized the company around functions: primarily sales and manufacturing. The structure served DuPont well, particularly in World War I, when in response to overwhelming demand DuPont vertically integrated its supply chain, and grew to become one of the largest companies in the world.

After the war, DuPont needed to diversify, and paint, which involved a similar compound to gunpowder, was the area they chose to focus on. Yet, despite the fact DuPont was perhaps the most professionally run corporation in America, losses soared. Eventually, a disconnect between sales and manufacturing was identified as the root cause, and the cure was a new organization around two separate gunpowder and paint divisions.

The deeper details of Dupont are quite interesting, and worth getting into: in short, the entire reason Dupont started making paint was that the manufacturing process was very similar to gunpowder; the problem is that gunpowder sold on a tonnage basis to huge buyers (like the army), while paint was sold to individual customers in stores. The product may have been very similar but the business model was entirely different. The end result was that Dupont was using a sales and marketing organization that was built around selling to large customers to get their paint into retail stores, and it was massively inefficient; the more paint Dupont sold, the more money they lost.

The solution was, as noted in the excerpt, divisions organized around gunpowder and paint, each with their own sales and marketing teams, their own manufacturing heads, and their own quasi-CEOs with their own profit-and-loss responsibilities. And, as you might suspect, it was a massive success that has since been copied by nearly every large organization.

Except, of course, Apple.

Apple the Services Company

In January, in their Q1 2016 earnings call, the prepared remarks of Apple CEO Tim Cook and CFO Luca Maestri took a surprising turn: an extended amount of time was spent making the case that Apple was a services company. Cook stated:

Especially during a period of economic uncertainty, we believe it is important to appreciate that a significant portion of Apple’s revenue recurs over time…a growing portion of our revenue is directly driven by our existing install base. Because our customers are very satisfied and engaged, they spend a lot of time on their devices and purchase apps, content, and other services.

Maestri was much more to the point — these were the first words out of his mouth:

Each quarter, we report results for our Services category, which includes revenue from iTunes, the App Store, AppleCare, iCloud, Apple Pay, licensing, and some other items. Today, we would like to highlight the major drivers of growth in this category, which we have summarized on page three of our supplemental material.

That supplemental material is here, and the fact it even exists underscores how serious Apple is about this narrative. And frankly, they have reason to be: while the iPhone remains in a very strong position that I believe will return to growth next fiscal year, that growth will be far more tepid than it has been to date: all of the “low-hanging fruit” — new markets, new carriers, new screen-sizes — is gone, and the real competition for Apple are the still very-good iPhones their customers already have. To that end, making more and more money off of those preexisting customers is the natural next step in Apple’s growth.

The problem for Apple is that while iPhones may be gunpowder — the growth was certainly explosive! — services are paint. And, just as Dupont learned that having a similar manufacturing process did not lead to similar business model, the evidence is quite clear in my mind that having iPhone customers does not mean Apple is necessarily well-equipped to offer those customers compelling services. At least not yet.

The Difference Between Devices and Services

I suggested at the beginning of this piece that to objectively claim that Apple is unique you needed to think beyond products, but in fact I do believe that Apple’s products — their devices anyways — are superior, particularly if you value the finer details of industrial design, build quality, and little UI details like scrolling and responsiveness that seem so simple but are so hard to get right.2 And, frankly, it’s not surprising that Apple is good at this stuff for the exact reasons laid out above: everything about the company is designed to produce integrated devices that don’t sacrifice perfection for the sake of modularity.

The problem is that everything that goes into creating these jewel-like devices works against being good at services:

  • You only get one shot to get a device right, so all of Apple’s internal rhythms and processes are organized around delivering as perfect a product as possible at a specific moment in time.

    Services, on the other hand, which are subject to an effectively infinite number of variables ranging from bandwidth to device capability to hacking attempts to data integrity to power outages — the list goes on and on — can never be perfect; the ideal go-to-market is releasing a minimum viable product that is engineered for resiliency and then updated multiple times a week if not multiple times a day. The rhythms and processes are the exact opposite of what is required to build a great device.

  • As Apple is happy to tell you, a superior experience on a device comes from integration: the software can be tailored to the hardware, all the way down to the component level; this is why Apple designs their own system-on-a-chip hand-in-hand with iOS. Integration to this degree, though, is only possible when there is a static endpoint: the device that goes on sale to the public.

    In the case of services, though, which develop organically and iteratively, an integrated approach is unworkable: you can’t build everything from scratch multiple times a day. Rather, an effective set of services are modular in the extreme: different capabilities snap together like lego blocks to deliver different types of experiences, and each of those capabilities can be iterated on without disrupting the end product.

  • The fact that smartphones are such an important part of people’s lives, combined with the fact that physical objects can have additional consumer benefits like status, enables Apple to sell each iPhone with a huge amount of margin. However, not everyone values smartphones that much, or has the willingness to pay, which means Apple has to be ok with not serving the entire market; after all, to make a single iPhone costs money that has to be made up for in the purchase price.

    Services, though, have a very different business model. First, there is precious little evidence that consumers are willing to pay more than a nominal amount for services (if that!), which means the most profitable services make money through volume. Secondly, services are effectively free on a marginal basis; the real costs are fixed, which means that services business have a strong economic imperative to reach as many people as possible.

These differences get at the very fundamental reasons why Apple struggles with services: it’s not that the company is incompetent, but rather that the company is brilliant — brilliant at making devices, which require completely different business structures and incentives.

Apple’s Services Problem

Late last week news broke that Apple was considering adding search ads to the App Store. I detailed yesterday why I think this is less of a big deal for the industry than either advocates or detractors believe, but I do think this is a very big deal for what is says about Apple: namely, that the company is serious about building out its services business.

The question, though, is how serious; App Store search ads will be a relatively easy thing to implement, just as the App Store itself was in many respects an obvious — yet still revolutionary — addition to the iPhone.3 It’s worth noting, though, how poorly the App Store is generally run: Apple is not, in my estimation, deriving nearly the amount of strategic value they should be from the App Store. The iPhone and iPad should be home to an increasingly sophisticated and exclusive cadre of high-powered applications that make the idea of choosing another platform unthinkable, but sadly, such applications have no business model because of App Store policies.

Apple Music is in worse shape: the extent to which the product is succeeding is largely due to its tie-in with Apple’s hardware; however, were the service held to the same ease-of-use, fit-and-finish, and profitability standards of said hardware there would be panic in Cupertino.

Cloud services, meanwhile, are still less reliable than Apple’s competition, and the integration — Apple’s supposed strength! — with Apple’s software is at best a source of irritation and at worst very worrisome from a security perspective: little things like constantly being prompted to enter one’s password are not only annoying but also corrosive when it comes to what should be a healthy skepticism about sharing the keys to your life.

The problem in all these cases is that Apple simply isn’t set up organizationally to excel in these areas:

  • Apple values integration and perfection, which results in too many services being over-built and thus more difficult to iterate on or reuse elsewhere
  • Service releases (and software) are not iterative but rather tied to hardware releases
  • Apple’s focus on secrecy means many teams end up building new services from scratch instead of reusing components

The root problem in all these cases is the lack of accountability: as long as the iPhone keeps the money flowing and the captive customers coming, it doesn’t really matter if Apple’s services are as good as they could be. People will still use the App Store, Apple Music, and iCloud, simply because the iPhone is so good.

What they won’t do, though, is use Apple Pay: an extension of Apple’s unitary vision (and another manifestation of the problems underlying my critique of the App Store) is a struggle to partner effectively, particularly with vast ecosystems driven by incentives, not backroom deals. Apple Pay could be the foundation for a tremendous amount of value but Apple isn’t doing the grunt work to get it off the ground (iMessage fits here as well).

You can see the same pattern with HomeKit, or Siri: the Amazon Echo is quietly taking over the home automation market with a simple API that is easy-to-integrate with and easy-to-understand; Apple, meanwhile, has yet to announce a Siri API even as it struggles to deliver natural language interaction that is simply not what the company is good at.

Both examples are even more worrisome when you consider Apple Watch: the Watch will truly realize its value when it becomes the key to interacting with your environment; getting there, though, means nailing services, partnerships, and APIs that are good, not perfect.

How Apple Can Excel at Services

The solution to all these problems — and the key to Apple actually delivering on its services vision — is to start with the question of accountability and work backwards: Apple’s services need to be separated from the devices that are core to the company, and the managers of those services need to be held accountable via dollars and cents.

This last point is surely anathema to Apple: the company famously only has one P&L4 — the number it delivers to Wall Street — and I absolutely agree that is foundational to Apple’s success. Removing the position of Senior Vice President of iPod made it far easier to obsolete it with the iPhone,5 and the fact there was no Senior Vice President of the Mac made it easier to come out with the iPad. Apple has displayed a remarkable unity of purpose that is only truly possible with a unitary organization, which is exactly why restoring that structure was Jobs’ first move upon his return.

But again, Jobs’ next move was slashing the product line, and that wasn’t only for reasons of focus and customer confusion: the fact is that unitary organizations do not scale to different business models, and if Apple is truly serious about services — and the existence of the relatively cheap yet full-featured iPhone SE suggests they are — they need to follow Dupont’s example.

Apple will not fix the services it already has, or deliver on the promise of the services its hardware might yet enable, unless a new kind of organization is built around these services that has a fundamentally different structure, different incentives, and different rhythms from Apple’s device teams. You don’t make great products because you want to make great products; you make great products by creating the conditions where great products can be produced.

Apple’s Dupont Moment

To be honest, I’m not sure Apple has it in them; indeed, Dupont nearly didn’t. Listen to these passages from Richard Tedlow’s book Denial and see if they ring familiar:

Irénée du Pont did not like this proposal [to organize the company by divisions], despite the fact that it came from his top people — seasoned executives all. It violated the “principle of specialization,” which had served DuPont so well. Irénée was still wedded to the idea of functional rather than product specialization…

Middle management — the men closest to the problems and seeking practical solutions for them — felt one way. Top management — which had created the modern DuPont company and seen that creation grow to un-imagined wealth and size — felt another…

Four years ago, Cook told a Goldman Sach’s investment conference:

They’re not things where we run separate [profits and losses] on, because we don’t do that — we don’t believe in that. We manage the company at the top and just have one [profit and loss] and don’t worry about the iCloud team making money and the Siri team making money. We want to have a great customer experience, and we think measuring all these things at that level would never achieve such a thing…

Apple is this unique company, unique culture that you can’t replicate. And I’m not going to witness or permit the slow undoing of it, because I believe in it so deeply. Steve grilled in all of us, over many years, that the company should revolve around great products, and that we should stay extremely focused on few things. Rather than try to do so many that we did nothing well.

Unlike many, I’m not bothered that Apple sells multiple variations of iPhone, iPads, etc. Scaling to variations is simply a matter of money and experience, which Apple has in spades. Services, though, are a fundamentally different problem that require a fundamentally different organization. If Apple is serious about services, then Cook’s promise that Apple would stay “extremely focused” is an empty one, and the insistence on a single type of organizational structure changes from enhancing Apple’s quality to actively detracting.6

Tedlow concluded:

It is extraordinarily difficult to bring about change in a big company. Leadership, it has been said, consists of using minimum problems to create maximum positive change. By that standard, DuPont did well, but it could have done better. Only when the firm was on the brink of disaster, in the midst of a crisis produced by one of the worst years in its history, was it able to reconcile itself to the fact that yesterday’s structure was acting as a barrier against rather than an avenue toward tomorrow’s strategy.

Something has to give: either what makes Apple Apple, or Apple’s newfound ambitions; the measure of Cook’s leadership will be how long it takes for him to stop straddling the fence.

  1. If you’re interested in this topic you can also read the followup: The Uncanny Valley of a Functional Organization []
  2. If you disagree, that’s ok! I also believe that if you value things like flexibility and integration with services — which I’m getting to — that Android phones (which I own and use regularly) are better; furthermore, I am well aware of and have written extensively about what I and many others perceive as Apple’s declining software quality. Please bear with me here. []
  3. To clarify, the implementation of the App Store was brilliant; the idea of allowing 3rd-party apps was obvious []
  4. Profit and loss, the metric on which divisional managers are measured []
  5. Tony Fadell left (with, reportedly, not much effort to keep him) after losing out to Scott Forstall’s vision of the iPhone, and it is telling that Apple has not had a product-centric executive member since []
  6. One important thing to note: Apple’s Retail division is a separate division with its own organizational structure and own P&L; Ron Johnson knew that was necessary to make the division work []