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  • An Interview with Eric Jackson at Forbes

    Eric Jackson recently interviewed me for his column at Forbes. I’m cross-posting here my answers to the tech industry related questions. Check out the full interview to read more about me personally and the background of stratechery.

    Q: Where is Apple at right now as a company in this post-Steve Jobs period?

    A: I think, were Steve Jobs still here, Apple would be in the exact same position: wildly successful financially, with justifiable skepticism about their future growth prospects, and unjustifiable skepticism about their short-term opportunities.

    The iPhone was in many ways a once-in-a-generation business opportunity: carriers are paying Apple handsomely to disrupt the personal computer business, just because Apple’s product happens to have an app that makes phone calls. Oh, and that product is one that is a necessity for almost every person on earth. It’s difficult to imagine a more lucrative opportunity, and fair to question how Apple can grow from such a large profit baseline (then again, it was hard to imagine a better business opportunity than levying a massive tax on every single computer just as computers became a necessity for every business and home, i.e. the Microsoft model, yet it turned out even better opportunities existed).

    What’s not justified is the assumption that iPhone sales are going to suddenly collapse in the face of lower-cost, “good-enough” Android-based phones. This sort of thinking is primarily the provence of analysts with their roots in PCs who witnessed the race to the bottom among Windows OEM’s, and it ignores that the PC market was primarily driven by businesses, where the buyers were not the users, and thus highly focused on price. The iPhone, on the other hand, along with all of Apple’s products, competes for consumers, and every other consumer sector offers evidence that there is a sizable portion of consumers who make purchase decisions for more reasons than just price. Apple, with their focus on the user experience, has always been a consumer company, and in a lot of ways their success over the past decade is a result of consumers embracing technology just like businesses did in the 80s and 90s. The right company, in the right place, at the right time with the right product.

    Steve Jobs certainly played a major role in that, and his most underrated quality in my opinion was his patience (on the flip side, one of Microsoft’s biggest failings is their timing). However, the values Jobs insisted Apple embody – quality, simplicity, the “feel” of something – are actually not that difficult to understand. There is no magic formula, just the incredibly difficult work of making choices and executing in a way that ensures those values come through in the products.

    The problem, though, is that those qualities aren’t easily measured or put on a spreadsheet. A lot of analysts handled that uncertainty by simply ignoring them, and then, when Apple continued to surprise, Steve Jobs became the scapegoat for success. And, now that he’s gone, these analysts can’t imagine how Apple can be successful even though the reasons remain just as clear as ever. Apple even made a commercial about it (the Designed in California spot)!

    In other words, I think Apple is fine. My long-term worry is about what happens when all of the old guard leave, and those in charge have only ever known success. But that’s still a ways off.

    Q: Is Tim Cook the right CEO for the company at this time?

    A: Absolutely, for the exact reasons I just articulated. Tim Cook’s speciality is making choices and driving execution, and from my observation both inside the company at Apple University and now, outside the company, he has long been the guardian of those values that make Apple, Apple.

    The problem with following a visionary, which Jobs absolutely was, is ensuring the revolution doesn’t destroy itself from the inside out once the unifying figure is gone. Cook is obviously very aware of this, which is why you hear him speak so much about collaboration and working well together, and is almost certainly why he removed Scott Forstall.

    Folks have said Forstall was the closest thing to Steve Jobs, and he’s more responsible for the iPhone than anyone, but Apple doesn’t need another Steve Jobs. Instead, Cook has worked to make the center of the company Apple itself, and the shared ideology design. It is a shared belief system that “No” is more important than “Yes,” that focus is essential to making great products, and that no one individual is essential. Not Steve Jobs, and certainly not Scott Forstall.

    Q: What’s going to be the “next big thing” for Apple? Watches, TVs, something else?

    A: Apple, despite their name change, has always been a personal computer company. They just keep reinventing what a personal computer is, and always in the direction of being more personal, and less computer. Look at the original Macintosh, saying “Hello,” to the candy-colored iMacs. Then came notebooks, which go with you, and now iPhones and iPads, more personal still.

    And now, with technology like TouchID and the M7, the iPhone is becoming even more personal. Whatever comes after the iPhone, and Apple is certainly thinking about just that, will make computing even more invisible, yet even more omnipresent at the same time. Bicycle of the mind indeed! Moreover, as computing becomes even more personal, the door opens to many new opportunities, whether it be security, identity, payments, etc., lots of which are very lucrative.

    Of course, Apple has always had a great accessory business as well; laser printers in the 80s and 90s, the iPod in the oughts, and the Apple TV today. I think, though, these types of products will always tend to enhance the primary, personal products, as opposed to being standalone moneymakers (the iPod was an obvious exception).

    There are two certainties though: whatever comes next is having its foundations being laid now, just like iTunes and OS X laid the foundation for the iPhone; that’s why things like the M7 are so intriguing. The other certainty is that whatever is next will likely be dismissed initially for being too limited, although it will do a few things perfectly. And then, over the next several years, Apple will iterate and iterate, until we wondered how we ever lived without.

    Q: What’s your take on how they’re handling their expansion into China, India, and other emerging markets?

    A: As I noted earlier, Apple pursues customers for whom price is not the overriding concern. They’re not gouging people, but they’re also not chasing the low end. Moreover, while a lot of their value add is in their software and hardware, they also add value through services, including their retail stores, iTunes ecosystem, App Store, etc. This has some important implications for emerging markets: first, a much smaller segment of the population can likely straight up afford their products, and second, the benefit of Apple’s service offering are likely much more limited. I think India is very much the poster child for these challenges, and Apple’s share is commensurate with that.

    China is interesting, though, because while some of the same issues apply, Apple’s brand is very highly valued as a status symbol. China is the fastest-growing market by far for all of the world’s luxury brands, and Apple is a part of that.

    What Apple is clearly not going to do is offer an “emerging market” version of their products, and while I get the consternation about that, given the inherent weakness Apple has in emerging markets relative to developed markets, it’s not surprising that their first move to grow share beyond the flagship iPhone – the 5C – is much more attractive in developed markets with increased subsidies (which, in and of themselves, are a by-product of more developed economies).

    Q: As you look at the rest of the mobile internet competitive landscape, do you expect any big surprises from other players (good or bad) in the next 5 years?

    A: The bear case that I pilloried above, that the iPhone is going to somehow collapse in the face of “good enough” Android phones, is actually much more applicable to Samsung. Samsung has very little in the way of meaningful differentiation compared to cheaper Android, and they are going to increasingly struggle to keep up their average selling prices and margins. That said, the strength of their supply chain is extraordinary, and they are nothing if not adaptable.

    Amazon is a big wildcard, but mostly in the US. Anything revolutionary they do in phone pricing, though, is likely going to be about the contract price, perhaps as an MVNO.

    Microsoft is worth watching, as well, for the opposite reason. Their days of owning the OS layer are over, but they don’t seem willing to accept this. The problem is that the opportunity cost of not accepting that are massive: there has been a window for the last couple of years to effectively build a platform on top of Android and even iOS based on premium services, including Office, but that window (no pun intended) is closing quickly. Regardless, it’s difficult to see Microsoft having the sort of revenue opportunities going forward to support 130,000 employees, and the cuts, when they come, will be very painful. It makes me sad.

    Q: Who will be the next CEO at Microsoft?

    A: One person I don’t think it will be is Stephen Elop. While it’s hard to come up with a lot of good things to say about Microsoft’s Board of Directors, I simply can’t fathom how you could give the CEO job to someone who, the last time he was CEO, effectively accelerated a declining business into the ground. Then again, I feel the Nokia purchase has the chance to do just that, so who knows?

    I’ve heard the name of Tony Bates thrown around; he’s already there, but still has enough outsider bonafides to seem like a fresh change, and he’s managed in a large organization at Cisco. I don’t know much about him, though, although I do think Skype has really dropped the ball in the shift to mobile; it has remained too focus on the voice experience, and not nearly enough on the messaging experience.

    The person I would love to see be CEO is Kurt DelBene, the recently departed head of Office. Office has, over the last few years, transitioned its business model to a service offering in the form of Office365. It’s still small but one of the most exciting products at Microsoft (unfortunately, it’s paying a huge strategy tax to Windows by not being available on the iPad, and only on the iPhone/Android this past year). Moreover, it’s a model for where Microsoft needs to go as a company: up the stack into services. Unfortunately, I don’t think it’s going to happen, not least of all because his wife has moved to the other Washington as a Congresswoman.

    Thanks to Eric for the interview. Check out the whole thing, including more about myself personally and the background of this site, here.

  • What Clayton Christensen Got Wrong

    There’s no question Clayton Christensen, who developed the theory of disruption, is Silicon Valley’s favorite business school professor. For me, diving deep into his thinking in a corporate innovation class was a breath of fresh air from management theory that explained all of corporate America but for its most successful company – Apple.

    It’s Apple, though, that has long been Christensen’s bugaboo:

    • In a January 2006 interview with Businessweek, Christensen predicted the imminent demise of the iPod:

      Q: Can Apple keep it up?

      Christensen: I don’t think so. Look at any industry — not just computers and MP3 players. You also see it in aircrafts and software, and medical devices, and over and over. During the early stages of an industry, when the functionality and reliability of a product isn’t yet adequate to meet customer’s needs, a proprietary solution is almost always the right solution — because it allows you to knit all the pieces together in an optimized way.

      But once the technology matures and becomes good enough, industry standards emerge. That leads to the standardization of interfaces, which lets companies specialize on pieces of the overall system, and the product becomes modular. At that point, the competitive advantage of the early leader dissipates, and the ability to make money migrates to whoever controls the performance-defining subsystem.

    • In a June 2007 interview, again with Businessweek, Christensen reiterated that the iPod was doomed, and further predicted that the iPhone would not be successful:1

      The iPhone is a sustaining technology relative to Nokia. In other words, Apple is leaping ahead on the sustaining curve [by building a better phone]. But the prediction of the theory would be that Apple won’t succeed with the iPhone. They’ve launched an innovation that the existing players in the industry are heavily motivated to beat: It’s not [truly] disruptive. History speaks pretty loudly on that, that the probability of success is going to be limited.

    • In a May 2012 episode of the Critical Path with Horace Dediu, Christensen again announced his pessimism about the iPhone. Forbes has a useful summary:

      Christensen’s second concern is that although integrated approaches in technology can be quite successful for a period, in the end modular approaches to technology always defeat integrated approaches. Christensen said:

      “The transition from proprietary architecture to open modular architecture just happens over and over again. It happened in the personal computer. Although it didn’t kill Apple’s computer business, it relegated Apple to the status of a minor player. The iPod is a proprietary integrated product, although that is becoming quite modular. You can download your music from Amazon as easily as you can from iTunes. You also see modularity organized around the Android operating system that is growing much faster than the iPhone. So I worry that modularity will do its work on Apple.”

    It is this concern that is the primary bear narrative about Apple. But it’s wrong, because the theory of low-end disruption is fundamentally flawed. And Christensen is going to go 0 for 3.

    Two Theories of Disruption

    That final excerpt is useful in that it highlights the fact Christensen has two theories of disruption.2

    The original theory of disruption, now known as new market disruption, was detailed in Christensen’s seminal paper Disruptive Technologies: Catching the Wave and expanded on in the classic book The Innovator’s Dilemma. Based primarily on a detailed study of the disk drive industry, the theory of new market disruption describes how incumbent companies ignore new technologies that don’t serve the needs of their customers or fit within their existing business models. However, as the new technology, which excels on completely different attributes than the incumbent’s product, continues to mature, it eventually takes over the market.

    This remains an incredibly elegant and powerful theory, and I fully subscribe to it. We are, in fact, seeing it in action with Windows – the incumbent – and the iPad and other tablets; new technology that is inferior on attributes that matter to Windows’ best customers, but superior on other attributes that matter to many others. (My belief in this theory is why I have been, to my own personal surprise, more sympathetic to Steve Ballmer – here and here – than most).

    It is Christensen’s second theory of disruption – low-end disruption – that I believe is flawed. Christensen first described this theory in Disruption, Disintegration and the dissipation of differentiability3, and expanded on it in The Innovator’s Solution. It is this theory that is at the basis of Christensen’s critique of Apple quoted above.

    Briefly, an integrated approach wins at the beginning of a new market, because it produces a superior product that customers are willing to pay for. However, as a product category matures, even modular products become “good enough” – customers may know that the integrated product has superior features or specs, but they aren’t willing to pay more, and thus the low-priced providers, who build a product from parts with prices ground down by competition, come to own the market. Christensen was sure this would happen with the iPod, and he – and his many adherents – are sure it will happen to the iPhone.

    In other words, it’s not enough to say the iPhone has saturated the high end market and that growth will slow; rather, the iPhone will soon overshoot customers completely, and will in fact plummet in total sales in the face of good-enough Androids available for hundreds of dollars less than the overpriced iPhone 5C.

    The Flaw in the Theory

    Interestingly, Christensen himself laid out his theory’s primary flaw in the first quote excerpted above (from 2006):

    You also see it in aircrafts and software, and medical devices, and over and over.

    That is the problem: Consumers don’t buy aircraft, software, or medical devices. Businesses do.

    Christensen’s theory is based on examples drawn from buying decisions made by businesses, not consumers.4 The reason this matters is that the theory of low-end disruption presumes:

    • Buyers are rational
    • Every attribute that matters can be documented and measured
    • Modular providers can become “good enough” on all the attributes that matter to the buyers

    All three of the assumptions fail in the consumer market, and this, ultimately, is why Christensen’s theory fails as well. Let me take each one in turn:

    Consumers Aren’t Rational

    When I say “rational”, I’m referring to the Rational Choice Theory, which underpins traditional economic and business theory. Basically – and forgive my simplification – a rational buyer is one who consistently and accurately weighs benefits and costs and chooses accordingly.

    In the case of low-end disruption, the rational buyer considers the superior integrated offering and the inferior (but still good) modular offering, decides the latter is “good enough,” and buys it because it is cheaper. The buyer knows the integrated offering is better, but the buyer is unwilling to pay a premium for features the buyer does not need.

    The problem with rational choice theory can be stated in two ways. The first is to say that consumers are not rational. They have widely varying motivations, are susceptible to advertising, lack product knowledge, fall prey to the need for instant gratification, etc. I prefer to think that consumers are actually perfectly rational, but that our definition of rationality needs to dramatically expand beyond what is easily quantified.

    Interestingly, though, business buyers are usually extremely rational. A CIO, for example, must justify a software purchase, and said justification usually comes down to balancing lists of features versus prices. Whatever solution scores best, wins. In other words, the first assumption underlying the theory of low-end disruption holds in the business-to-business market, but fails in the consumer market.

    Every attribute that matters can not be documented and measured

    The attribute most valued by consumers, assuming a product is at least in the general vicinity of a need, is ease-of-use. It’s not the only one – again, doing a job-that-needs-done is most important – but all things being equal, consumers prefer a superior user experience.

    What is interesting about this attribute is that it is impossible to overshoot. I expanded on this in Apple and the Innovator’s Dilemma, an academic paper I wrote in 2010 that examined why the iPod wasn’t disrupted:5

    Apple’s focus on user experience as a differentiator has significant strategic implications as well, particularly in the context of the Innovator’s Dilemma: namely, it is impossible for a user experience to be too good. Competitors can only hope to match or surpass the original product when it comes to the user experience; the original product will never overshoot (has anyone turned to an “inferior” product because the better one was too enjoyable?). There is no better example than the original Macintosh, which maintained relevance only because of a superior user experience. It was only when Windows 95 was “good enough” that the Macintosh’s plummet began in earnest. This in some respects completely exempts Apple from the product trajectory trap, at least when it comes to their prime differentiation.

    You see this time and again when it comes to iPhone differentiation, which focused on the actual experience, not numbers on a spec sheet:

    • The iPhone has a superior touchscreen (which can only be felt, not bullet-pointed), but lower resolution than competing smartphones
    • The iPhone has bigger pixels in its camera, but fewer of them relative to competing smartphones
    • The iPhone has superior performance-per-watt, but fewer cores and lower clock speeds than competing smartphones
    • The iPhone has superior battery life compared to a similarly-sized competing smartphone, or a much-smaller size compared to a competing smartphone with equivalent battery life
    • The iPhone 5S’s biggest selling point is TouchID, technology that actually affects people’s day-to-day life

    Listen again to Jony Ive’s introduction of the iPhone 5S and TouchID:

    iPhone 5S is our most refined iPhone to date. It is meticulously designed, engineered and crafted, but it’s the remarkable innovation inside the iPhone 5S that sets a new precedent. It’s not just rampant technology for technology’s sake.

    Every single component, every process, has been considered and measured to make sure that it’s truly useful and that it actually enhances the user’s experience.

    This care, this consideration, extends to how we protect all of the important information that you carry with you on your iPhone. It’s what led us to create TouchID.

    The business buyer, famously, does not care about the user experience. They are not the user, and so items that change how a product feels or that eliminate small annoyances simply don’t make it into their rational decision making process.

    Again, though, Christensen’s research is tilted towards business buyers. Critically, this includes the PC. For the most of its history, the vast majority of PC purchasers have been businesses, who have bought PCs on speeds, feeds, and ultimately, price. Benedict Evans wrote a great piece last May called Apple, Open and Learning From History detailing this exact point:

    In the 1990s, the PC market was mostly a corporate market (roughly 75% of volume). Corporate buyers wanted a commodity. They were buying 500 or 5000 boxes, they wanted them all the same and they wanted to be able to order 500 or 5000 more roughly the same next year. They wanted to compare 4 vendors on price with the same spec sheet. They didn’t care what they looked like (and they were going under a desk anyway) and they didn’t care how easy it was for non-technical people to set them up because the users would never touch the configuration. Nor did they care much about the user interface, because most of the users were only going to be running 1 or 2 apps anyway.

    These are the buyers at the root of Christensen’s theory of low-end disruption, and they don’t care about what can’t be measured. They are not the buyers driving the smartphone market, who do.

    Modular providers can not become “good enough” on all the attributes that matter to the buyers

    The traditional business theory about vertical integration rests on the costs and controls. This article from QuickMBA describes it well (emphasis mine):

    Two issues that should be considered when deciding to vertically integrate [are] cost and control. The cost aspect depends on the cost of market transactions between firms versus the cost of administering the same activities internally within a single firm. The second issue is the impact of asset control, which can impact barriers to entry and which can assure cooperation of key value-adding players.

    The issue I have with this analysis of vertical integration – and this is exactly what I was taught at business school – is that the only considered costs are financial. But there are other, more difficult to quantify costs. Modularization incurs costs in the design and experience of using products that cannot be overcome, yet cannot be measured. Business buyers – and the analysts who study them – simply ignore them, but consumers don’t. Some consumers inherently know and value quality, look-and-feel, and attention to detail, and are willing to pay a premium that far exceeds the financial costs of being vertically integrated.

    None of these types of consumers – and the attributes that appeal to them – fit into the theory of low-end disruption, nor were the sort of products that they buy included in Christensen’s research.

    Counter-examples

    With this critique in mind – that the theory of low-end disruption only applies to business-to-business markets – it’s worth examining counter-examples beyond Apple.

    An obvious one in technology is consoles. Every successful console has been closed and integrated, thus providing a superior user experience. There has been no low-end disruption (although, interestingly, consoles are falling prey to new market disruption – again, I fully subscribe to that theory).

    Another example is textiles – everything from shoes to clothing to accessories. According to low-end disruption, a bag is a bag is a bag. The credit card statement reflecting my wife’s birthday says otherwise!

    Cars are particularly interesting because in Disruption, Disintegration and the Dissipation of Differentiability Christensen himself offered it up as a potential proving ground for his theory. While Christensen’s prediction was focused on a shift of profits from car makers to suppliers, it’s the sustainable differentiation between brands that Tim Cook highlighted in his own interview with Businessweek:

    Q: Toyota makes a very nice car at many levels for a lot of people in the world.

    TC: They do.

    Q: But that’s different than a BMW.

    TC: It is. It is, and the fortunate thing, though, is that we can provide a substantial number of customers a really great experience with really high-quality products. You said BMW, and I only speak up there because BMW’s share of the car market is a lot less than Apple’s share of the tablet market.

    So we’ve found a way to make our products such that the experience is jaw-dropping. The quality and precision are just unbelievable, really. But we can do this for a lot of people. A whole lot of people.

    Not all consumers value – or can afford – what Apple has to offer. A large majority, in fact. But the idea that Apple is going to start losing consumers because Android is “good enough” and cheaper to boot flies in the face of consumer behavior in every other market. Moreover, in absolute terms, the iPhone is significantly less expensive relative to a good-enough Android phone than BMW is to Toyota, or a high-end bag to one you’d find in a department store.

    An Alternative Framework: Back to Porter

    The framework that makes the most sense for the consumer market comes from another Harvard professor, Michael Porter.

    Michael Porter has described a category scheme consisting of three general types of strategies that are commonly used by businesses to achieve and maintain competitive advantage. These three generic strategies are defined along two dimensions: strategic scope and strategic strength. Strategic scope is a demand-side dimension and looks at the size and composition of the market you intend to target. Strategic strength is a supply-side dimension and looks at the strength or core competency of the firm. In particular he identified two competencies that he felt were most important: product differentiation and product cost (efficiency).

    Porter's Three Sustainable Generic Strategies
    Porter’s Three Sustainable Generic Strategies

    Low-cost is absolutely a viable strategy. The existence of Wal-Mart, Wrangler, and Kia attest to that. But differentiation is a sustainable strategy as well, and nothing about technology changes that. True, you can’t differentiate on technology alone, but Apple has been clear – explicit even – that their focus is on the sort of differentiation that matters to consumers. Listen again to the words of the commercial aired during WWDC:

    This is it.
    This is what matters.
    The experience of a product.
    How it will make someone feel.
    Will it make life better?
    Does it deserve to exist?
    We spend a lot of time on a few great things, until every idea we touch enhances each life it touches.
    You may rarely look at it, but you’ll always feel it.
    This is our signature, and it means everything.

    Apple is – and, for at least the last 15 years, has been – focused exactly on the blind spot in the theory of low-end disruption: differentiation based on design which, while it can’t be measured, can certainly be felt by consumers who are both buyers and users.

    It’s time for the theory to change.

    1. Christensen later admitted he was wrong about the iPhone, noting that it wasn’t a phone at all; rather, it was disruptive to computing. I actually think this points to a missing piece in disruption theory, but that will have to wait for another essay. This is long enough ↩

    2. Christensen’s first concern about Apple:

      Christensen’s first concern is that Apple has yet to confront serious self-disruption.

      “First, by analogy, if you go back to the 1950s when Akio Morita, the founder of Sony [SNE] was launching this sequence of portable players, portable radio, portable television, portable video recording, they knocked the ball out of the park, time and time again. Each one of those was disruptive relative to the traditional leader in each of those fields. So they were disruptive relative to the leader, but these were not disruptive to Sony itself. When they went from a portable radio, to television to video and so on, each one because of the margins that they offered was very attractive internally to go after these things. When Sony finally ran into an innovation that was disruptive not only to the market but also to Sony itself, then they stumbled. The first time that that happened was when downloadable music became viable through Napster and others. Because Sony had a really big CD business, this was disruptive to Sony itself, and they lost the opportunity and gave it to Apple and the iPod.

      “I worry that Apple is in the same situation, in that the sequence of extraordinary products has been disruptive relative to the traditional competitors in the marketplace, but relative to Apple’s business model, they have not been disruptive to Apple. So they haven’t seen this problem before. I worry that maybe they have not learned to recognize what’s been happening, because they haven’t seen this kind of problem before.“

      This is spot-on. Apple has never faced true new market disruption that ruins their business model. ↩

    3. I find it deeply disappointing that this article can be found at a site that includes “Oxford” in its name even as the title dispenses with ought-to-be-used Oxford comma ↩

    4. The original article looked at disk drives, PCs (more on those in a moment), mortgage banking, microprocessors, and software ↩

    5. Much to my delight, Christensen said I did a “good job” ↩

  • The $550 iPhone 5C Makes Perfect Sense

    I can sympathize with the inability of many folks to grok exactly what Apple is thinking with iPhone 5C pricing. I myself was confused until just before launch, when I wrote Thinking about iPhone Pricing and honed in on the idea of “good-enough.”

    In the case of the iPhone, the 3G was clearly better than the 1st iPhone (enclosure notwithstanding), as was the 3GS relative to the 3G, and the 4 to the 3GS. Ultimately, Apple feels it was the iPhone 5 that is “good enough,” as seen by their willingness to finally make a mid-range version…the line has been set; clearly we won’t see a truly low-priced iPhone until Apple can include iPhone 5-level technology at a price they are comfortable with.

    Tim Cook emphasized this point in an interview with Businessweek:

    “We never had an objective to sell a low-cost phone,” says Cook. “Our primary objective is to sell a great phone and provide a great experience, and we figured out a way to do it at a lower cost.”

    So that’s reason number one that the iPhone 5C is $550. Apple is focused on product-quality first, price second.

    However, even if Apple had decided they could make a phone for less, it still wouldn’t have been a good idea for two additional reasons.

    Apple’s Three Markets

    The first thing to consider is that the iPhone is effectively offered in three very different markets, something I didn’t quite understand when I wrote a post last spring called The Visual Case for a Low-Cost iPhone:

    I combined carrier ARPU by country with browser share data from StatCounter. Countries are ordered by ARPU.

    • The gray area is the average revenue per mobile-cellular subscription
    • The blue line is the linear trend line for iOS browser share
    • The green line is the linear trend line for Android browser share
    iPhone browsing share is correlated to carrier ARPU. Click for larger version.
    iPhone browsing share is correlated to carrier ARPU. Click for larger version.

    I find this very illuminative. If we assume ARPU is a good proxy for subsidization, then this strongly supports the idea that the iPhone is highly competitive1 versus Android in subsidized markets (the left side), but is simply too expensive in non-subsidized markets (the right side).

    The right side of this chart is the visual case for a low-cost iPhone.

    The chart was useful, but my conclusion was totally wrong. I didn’t really think through the implications of there being three iPhone markets.

    The first iPhone market is the extreme left: Canada, Japan, and the US. These markets disguise the true cost of an iPhone – you pay the same (high) contract rate no matter which phone you choose. Unsurprisingly, the iPhone is very successful here. For the sake of simplicity I’m going to call this the American-style market.

    The second iPhone market is the rest of the left side (mostly Europe – again, for simplicity’s sake, I’m calling it European-style). These markets provide a subsidy along with contract rates that change with the price of the phone – it’s much clearer the iPhone is more expensive, although you don’t necessarily pay a large amount up front. In other words, if you get an iPhone, you’re paying more per month than you are for a very fine Android phone.

    The third iPhone market is on the right side of the chart, and while European-style subsidies may be available, most consumers pay full price for the phone in a separate transaction from their mobile contract, or, more likely, their prepaid fill-up. I’m going to call this the Asian-style model (most of Asia fits here, but Japan and South Korea are notable exceptions).

    Looking again at that chart, and with the realities of these three markets in mind, it’s not so much that the iPhone has saturated the American-style and European-style markets, and ought to focus on the Asian-style one; rather, the iPhone has saturated the high end in all three markets – the high end just varies in accessibility ($200 for American-style, $650 for Asian-style). And, if you accept that the iPhone is in roughly the same competitive position in all three markets – that the difference in market share is due to inherent structure of the market – then it’s not at all obvious Apple should focus on the SE Asia-style market. In fact, it’s obvious they shouldn’t.

    While any discussion about the iPhone touches on subsidies, the subsidies themselves – and the degree to which the iPhone is accessible – are much more a function of the underlying economy. Countries to the left are more service-oriented, and have higher purchasing power. There is much higher credit-card penetration, and, generally speaking, greater respect for copyright. All of these factors make the left side of that chart much more attractive to Apple. Apple’s ecosystem and overall value prop is certainly the highest in the United States for all of the factors just listed, and the value-add of their ecosystem roughly tracks the same left-to-right listing of countries in the chart above.

    Consider apps: Distimo just posted their list of the top global apps for August, including the top revenue generating companies:

    From Distimo. Click the image for the original article.
    From Distimo. Click the image for the original article.

    There’s the American-style market – the United States; Japan; and Canada, clearly punching above its population size. Consumers in these countries are the type of customers for whom Apple can provide the most value with their ecosystem. Moreover, it’s customers in these countries who are driving Google Play revenue:

    From Distimo - click the image for the original article
    From Distimo – click the image for the original article

    The 5C is squarely targeted at those blue pieces of pie, and thus, is priced in a way that makes sense for those markets – with a subsidy in mind. I wrote in Thinking About iPhone Pricing:

    The fact the 5C needs to be sold in both subsidized and unsubsidized markets makes the pricing tricky; in [American-style] subsidized markets, Apple is currently receiving a subsidy of around $450 on the iPhone 5. It wouldn’t make sense to unilaterally lower that – after all, it’s not like the carriers are going to lower iPhone service bills. This sets a floor of $450 for the unsubsidized 5C ($0 with contract). This also lets Apple dump the 4S, with its 3.5″ screen, 30-pin connector, and lack of LTE.

    $0, though, is problematic from a branding perspective. While a new phone, heavily advertised (unlike the old iPhone 4) and sold for $0 would move an incredible number of units, it would also create consumer expectations around $0 and associate Apple with “cheap.” I would imagine Apple is very hesitant to go there. $99 makes more sense. (This point on branding applies to the unsubsidized cost as well; in Asia, in particular, the iPhone’s biggest selling point is brand prestige, not apps or user experience. Apple will be happy to err on the side of more expensive.)

    $99, however, implies an unsubsidized cost of $550.

    (Oh how I regret that “however”!)

    To summarize,

    • There are three different types of markets the iPhone competes in
    • The iPhone has saturated the high-end in all three markets; the difference in overall market share is a function of the type of market it is
    • The Apple ecosystem is of most value in the American markets first, the European markets next, and the Asian-style markets last

    Therefore, it’s very rational for Apple to optimize its pricing for the American-style markets, and the most logical price is $550/$99.

    Money on the Table

    In Thinking About iPhone Pricing, I talked about demand curves:

    The most elementary thing to understand about pricing is the demand curve. In general, and as one might expect, the quantity sold has an inverse correlation to price.

    Basic demand curve; as the price drops, the quantity sold increases. Click the image for the original article.
    Basic demand curve; as the price drops, the quantity sold increases. Click the image for the original article.

    The amount to which price influences quantity – i.e. the slope of the line – is the product’s elasticity. If reducing the price of a product by 10% results in 10% more being sold, then the product has an elasticity of 1. If a 10% reduction results in 15% more being sold, then the elasticity is 1.5.

    Depending on the elasticity, lower prices may or may not product additional profits. Consider a simplified example, using 5C pricing and a guess at component costs:

    With an elasticity of 1, having a price of $450 would result in 22 more units over the 100 unit baseline, but lower profits overall.

    An elasticity of 1.5, on the other hand, results in more profits at the $450 price point.

    I bring this up for two reasons:

    1. No one – probably including Apple – is quite sure exactly what the elasticity will be for the iPhone. See, the demand curve is usually, well, curved. It’s not as simple as I’ve presented it. Same with elasticity – it changes depending what price point you are at. While Apple could go lower cost, there is a very high likelihood they would, like the first example above, make less money than they could otherwise. It makes a lot more sense to gradually move down the demand curve and build out your knowledge of the market.
    2. It’s not at all certain the iPhone will stop at two new models a year. In fact, I wouldn’t be surprised if 2014 brought a $450 5C 2nd generation, with all new colors. Now you’re optimizing for three different points on the demand curve instead of undershooting on the low end and leaving money on the table.
      A well-designed multi-product strategy captures much more value. Click the image for the original article
      A well-designed multi-product strategy captures much more value. Click the image for the original article

    Summary and Risks

    To summarize, Apple’s decisions with the 5C are completely rational.

    1. Apple believe the iPhone 5 is the standard for “good enough” and won’t produce a “new” iPhone below that level. That means higher prices this year
    2. Apple’s “best” markets are the American-style ones, for reasons beyond simply subsidies. Thus, it makes sense for them to optimize pricing for those markets – i.e. $550/$99
    3. Expanding a product line is best done incrementally to ensure you are not leaving money on the table. You can’t have a high-end and low-end with nothing in the middle

    There are two risks in this approach, both having to do with apps. The first is losing the “new and shiny” app advantage. Incremental change will only slightly slow Android’s expansion, and while much of that expansion has low engagement, low engagement/user x many more users still equals more total engagement. Were, based on this equation, new apps and features to start coming to Android first, Apple would lose a major differentiator.

    However, I think this risk is a small one. The 5C will solidify Apple’s hold on the United States, where just under 50% of app developers live. Moreover, the 5C is focused on those blue pie slices – the Android users who are driving engagement.

    The other risk, though, is more localized. Specifically, iOS is on the verge of being a complete non-factor in several countries on the right side of that chart. In India, for example, iOS penetration is minuscule, meaning the local app advantage tilts towards Android. China is another significant market on the right side, although Apple enjoys such brand prestige that they are probably safer for now. Regardless, missing out on the fastest-growing markets is absolutely a concern.

    Ultimately, though, the $550 5C is very rational and a decision I now agree with.

    There is one more objection: isn’t Apple setting itself up for modular-based disruption? I addressed that here: What Clayton Christensen Got Wrong

    1. In fact, the iPhone mostly wins on the left; the trend line is dragged down by the right ↩

  • HTC’s – and Windows Phone’s – Missing Market

    According to Digitimes, HTC won’t use the top-of-the-line Qualcomm processor in their new phablet:

    HTC reportedly will adopt an old Qualcomm processor, the quad-core 1.7GHz Snapdragon S4 Pro APQ 8064, for production of its first large-size HTC One Max to be launched in October 2013, according to sources in the supply chain.

    Some sources said that HTC is being forced to use the old CPU model because it is unable to secure sufficient supply of Qualcomm’s high-end Snapdragon 800 processors, given that a handful of other brands, including Sony Mobile Communications, LG Electronics, Asustek Computer, Acer and Xiaomi Technology have all decided to use Qualcomm’s Snapdragon 800 family CPUs for most of their smartphone models to be launched in the second half of 2013.

    Horace Dediu has written at Asymco about the phenomenon of smartphone manufacturers never recovering once they stop being profitable (as HTC will no longer be after this quarter). There are many reasons this is the case – operator confidence likely looms the largest – but the complete loss of buying power in the components market is another.

    So it seems to be with HTC and the Snapdragon 800. Qualcomm will, understandably, prioritize companies with a more certain future and larger order size when it comes to delivery of their new SoC.

    I’ve written about HTC’s death spiral previously, including their component challenges, but it’s worth stepping back and examining how HTC reached this point.

    Originally a dominant Windows Mobile player, HTC was the first smartphone manufacturer to embrace Android, leaving them perfectly placed when desperate carriers who didn’t have the iPhone came calling. HTC, however, mistook their opportunity-based success as being directly attributable to their product prowess. And so, when Samsung entered the market, HTC quickly retreated to the top end of the market, making the “best” Android Phones, including the One X/S/V series last year, the Butterfly, and the One this year. All three models featured high-end industrial design, and prioritized fit-and-finish over things like removable batteries or expandable storage.

    The problem for HTC is that customers who value high-end industrial design also value fit-and-finish in software, and thus buy iPhones. High-end customers who reject the iPhone for Android usually do so because they seek more customization and flexibility; naturally, they also prefer hardware features such as the aforementioned removable battery and expandable storage, which the Galaxy S series is happy to provide.

    To put it another way, HTC has been targeting the high-end market with an inferior product. And now, to add insult to injury, they can’t even deliver top-of-the-line components for their phablet, the most un-iPhone-like premium device of all.

    In this way, HTC is very much the hardware version of Windows Phone. Windows Phone from day one targeted the iPhone, setting strict hardware baselines and severely limiting both OEM and carrier flexibility, ensuring minimal fragmentation. Unfortunately, customers who cared already had iPhones, and now Windows is stuck without the minimum components – apps – needed to compete.

    More broadly, Microsoft as a company has forgotten that their success in the ’80s – which flowed directly through to the ’90s and ’00s – was opportunity-based, not product-based. Microsoft rode IBM’s coattails – and missteps – to a dominant position in PCs, and the network effect took care of the rest.1 Attributing this success to a superior product results in the sort of overconfidence that matches the Zune up with the iPod, the Surface with the iPad, and Windows Phone with the iPhone.

    Both HTC and Windows Phone are now racing downmarket, but one does not undo one’s core competence and capabilities so easily. HTC simply doesn’t have the volume or cost structure to offer competitive prices, and Windows Phone’s hardware requirements are still too high to compete with feature phones and low-end Android.

    The comparison is even more interesting when you recall the shared beginning I referenced above; at one point, HTC manufactured over three-quarters of Windows Mobile devices. A shared ending seems to be in the cards as well.2

    1. It was the same way with Office, which capitalized on WordPerfect’s delay in adopting Windows 95 (Of course, it’s still a bit of an open question about who is to blame for said delay)  ↩

    2. So what should HTC have done?

      I think they should have retreated to their ODM roots and become the “house manufacturer” for carrier-branded phones. There is room for a “3rd”, but that 3rd does not mean a 3rd ecosystem; rather, it means a 3rd manufacturer. Carriers would have gladly embraced a partner willing to provide a counterweight to Apple and especially Samsung. ↩

  • There Are Two Twitters; Only One is Worth Investing In

    There are two Twitters. One is for special occasions only, while I am obsessed with the other. The ultimate value of the Twitter stock (TWTR?) is fully dependent on which of these two Twitters is on offer.

    Twitter #1: What’s Happening?

    The first version of Twitter isn’t hard to find:

    Twitter's homepage is focused on "What's Happening" i.e. Twitter #1
    Twitter’s homepage is focused on “What’s Happening” i.e. Twitter #1

    Welcome to Twitter.

    Find out what’s happening, right now, with the people and organizations you care about.

    This is the Twitter that is presented at Twitter.com, and in their mobile apps. This Twitter loads at the top, giving you the most recent information first; after all, isn’t that the point?

    This, of course, is the Twitter I use for special occasions only. I actually use a different app for this Twitter, so that I can scroll to the top of my timeline without losing my spot in the Twitter app I prefer. The problem for Twitter is that special occasions are rather rare, and, well, special, making it more difficult to sell advertising against.

    While I think this Twitter is valuable in certain cases, I don’t find this Twitter very compelling as a business, and would not invest in it.

    Twitter #2: What Matters?

    This is the Twitter that I use every day, all day. It’s my single most indispensable service; I would give up just about all of my favorite things, including my iPhone, before I gave up Twitter. For me, Twitter is the single most efficient way of learning what I am most interested in, and care the most about. The signal-to-noise ratio is fantastic, and the content perfectly tailored to my interests.

    Moreover, this version of Twitter is by far the best placed to make me respond to advertising. I’ve clicked on more than one sponsored tweet, and would likely find advertising placed through MoPub compelling as well. After all, Twitter knows exactly what I’m interested in, and that is valuable information indeed.

    How the Internet Has Changed Advertising

    Advertising is hardly new; even the ancient Egyptians used papyrus to make sales posters.1 However, over the last ten years it has undergone a profound shift.

    Previously, advertising channels like newspapers or television channels were the only means to a captive audience. For example, if you wanted to reach those living in Chicago, the Chicago Tribune or Sun Times were your primary options. This proved highly lucrative for those in the middle; their job was to create compelling content to ensure customers bought their product, which was in turn laden with advertising, from whence they made most of their money.

    The old advertising model involved a captive audience; a middle-man needed only to deliver content
    The old advertising model involved a captive audience; a middle-man needed only to deliver content

    The Internet has changed this in a few fundamental ways:

    • On the Internet, consumers are no longer captive. I have an effectively infinite array of choices for news, entertainment, etc., meaning the content that attracts me must truly stand out. Moreover, this massively inflates the amount of advertising inventory, destroying its worth.
    • There is no longer a secondary revenue stream from consumers; except for a few high-profile exceptions, consumers don’t pay for content.
    • The nature of Internet advertising makes it possible to gather much richer data about consumers than was ever possible offline.
    On the Internet, those in the middle have to deliver superior content and also collect superior targeting information
    On the Internet, those in the middle have to deliver superior content and also collect superior targeting information

    This has made life in the middle much more difficult, particularly for old-school advertising middlemen like newspapers. Commanding top rates depends not only on capturing consumers versus infinitely more competitors, but also knowing more about those consumers than anyone else. Targeting information is the new scarcity in advertising. It is the only way to sustainably increase average revenue per user.

    Twitter’s Potential

    Whereas Google is valuable because it knows what I want, when I want to get it, Facebook knows who I am, and who I know. Ideally, they also know who and what I like, but it’s a much weaker signal. Twitter, on the other hand, knows exactly what I like and what I’m interested in. It’s obvious both from what I tweet about, but especially based on who I follow.

    If an advertiser wants to reach someone like me – and they certainly do, given my spending habits – Twitter is by far the best way to find me. Were Twitter able to consistently capture this signal and deliver effective ad units that caught their user’s attention, they could command some of the highest average revenues per user on the Internet.

    Twitter’s Problem

    The problem for Twitter is that getting a user as finely tuned as myself is not at all an easy process. My interests are so easily identified because I constantly edit who I follow to make sure my signal-to-noise ratio is as high as possible.2 However, this sort of behavior is totally unnatural and overwhelming to a new user. I hesitate to tell others how valuable I find Twitter, simply because I don’t know how to explain to them how to make Twitter as useful to them as it is to me.

    Moreover, even for me, the experience is overwhelming. Because I find every tweet so valuable, I want to read them all, but if I’m away for more than a few hours it becomes burdensome in a way Twitter has purposely avoided.

    Twitter, then, is in a bit of a paradox. To maximize its advertising potential, it must somehow educate new users on how to finely tune their experience. Yet, having finely tuned the experience, the amount of pure information goodness becomes overwhelming in a way the “normal” experience with its fleeting noise simply isn’t.

    Twitter’s Uncanny Valley

    For the past several years Twitter has been solving this conundrum by pushing users towards immediacy and focusing on their real-time advantage. That is why their homepage focuses on “What is happening right now.” The idea that Twitter is for real time information – Twitter #1 – is easy to explain to new users, and avoids the need for all of the difficult product marketing decisions that are required to deliver Twitter #2, the perfect individualized news source.

    In some ways, Twitter has stayed on the safe side of the uncanny valley; they haven’t tried to be all they could be, which also means they haven’t crashed-and-burned.

    Click the image to read the article where I introduced the idea of the uncanny valley
    Click the image to read the article where I introduced the idea of the uncanny valley

    And yet, it’s Twitter #2 that has all the growth potential because of its ability to capture a superior signal about users. It’s not at all clear how to cross the valley, but I’m3 only buying the stock if they reach the other side.

    There are signs Twitter is going for it. For one, the new tweet box, which previously asked “What’s Happening,” recently switched to “Compose a new tweet…” Hopefully this is a sign of a reduced focus on the last five minutes.

    Moreover, Twitter is doing excellent work on the little-used Connect and Discover tabs. The best way to find new people to follow – to build that lucrative interest graph – has always been to look to the people you already follow, and Connect gives great insight into whom those you follow interact with. It’s a start to solving the problem; so is @MagicRecs, a mystery account that DMs you suggested people to follow.

    As for Discover, honestly, I hadn’t used it at all until I read Matt Buchanon’s must-read piece on the “Twitter of Tomorrow.”

    People have suspected for some time that the main Twitter timeline, which has remained text-only, might eventually look like Discover. With the evaporation of Discover in the forthcoming iOS app, as well as the shift to a more immersive stream that takes over the phone’s entire display, the stage finally seems set for that to happen, and for users to see photos, videos, and other media directly in the stream—much like Facebook’s Newsfeed.

    Horrified at this possibility, I opened up Discover for the first time in ages and…it was really good. I spent quite a bit of time reading tweets, interesting articles, and even following a new person or two. It was highly relevant and highly curated, all at the same time.

    In other words, it potentially begins to cut through the paradox: the more curated your following list, the better the content, yet the content is much less overwhelming. It’s smarter, and riskier, all at the same time. It’s taking Twitter’s biggest strength – a truly phenomenal product – and instead of trying to explain it better (which may be impossible) or dumb it down (as they have for the past few years), it’s changing it, potentially creating the virtuous alignment between user benefit and user information that leads to the most profitable types of companies in advertising.4

    And yet, it may go horribly wrong (if Buchanan is right, you can see the backlash coming now). Running that risk, however, is the only path to greatness.

    1. Thanks Wikipedia! ↩

    2. I actually finally gave up doing this with my following list; I now keep a secret list with a smaller number of people I absolutely don’t want to miss ↩

    3. The rhetorical “I”. Because I write about them here, I don’t plan on buying any regardless ↩

    4. To reemphasize the point, I am not saying this is like the Dickbar; rather, I’m arguing it is a potentially better product, particularly for normals. Us geeks will always have our 3rd-party speakeasy apps ↩

  • Two Minutes, Fifty-six Seconds

    After endless dithering, that’s how long it took me to know the iPhone 5C would cost $549.

    It was at two minutes, fifty-six seconds1 that Tim Cook said there would be a video – a video! – about the iTunes Festival.

    And it was awesome.

    In case you didn’t watch the whole video (and you really should – it’s only a couple of minutes), this clip of the ending captures why it matters:

    Message: Apple is cool.
    Message: Apple is cool.

    This was Apple, standing up and saying to all the pundits, to all the analysts, to everyone demanding a low price iPhone:

    NO!

    No, we will NOT compete on price, we will offer something our competitors can’t match.

    No, we are NOT selling a phone, we are selling an experience.

    No, we will NOT be cheap, but we will be cool.

    No, you in the tech press and on Wall Street do NOT understand Apple, but we believe that normal people love us, love our products, and will continue to buy, start to buy, or aspire to buy.

    Oh, and Samsung? Damn straight people line up for us. 20 million for a concert. “It’s like a product launch.”

    Apple's iTunes Festival video on the left, Samsung's Galaxy SIII commercial mocking those standing in line on the right
    Apple’s iTunes Festival video on the left, Samsung’s Galaxy SIII commercial mocking those standing in line on the right

    This attitude and emphasis on higher-order differentiation – the experience of using an iPhone – dominated the entire keynote and the presentation of features, with particularly emphasis throughout on the interplay between software and hardware.

    • Retail Look at our new store with an entire room devoted to service. Paying more for an iPhone is worth it.
    • iOS 7 You get all our new features, right away, for free. Only Apple gives updates immediately. Paying more for an iPhone is worth it.
    • iWork, iPhoto, and iMovie You get amazing software, that’s only available on iOS, with your new iPhone. Paying more for an iPhone is worth it.2
    • iPhone 5C It looks and feels amazing, with a “bespoke” assembly and “solid dense feel you would not expect from a plastic product.” Paying more for an iPhone is worth it.
    • A7 iPhone has the best performance. Paying more for an iPhone is worth it.
    • Infinity Blade Look at this game that is only possible on an iPhone. Paying more for an iPhone is worth it.
    • M7 iPhone fully integrates into every part of your day, and has exclusive apps like Nike+. Paying more for an iPhone is worth it.
    • Camera We don’t focus on stats, we focus on helping you take better pictures through our integration of hardware and software. Paying more for an iPhone is worth it.
    • Touch ID Apple notices and spends time on the tiny annoyances that you didn’t even notice, and does so by integrating hardware and software. And we want to protect your data, not use it. Paying more for an iPhone is worth it.

    If you disagree, well, we won’t sell you an iPhone.

    I wrote after the WWDC presentation that Tim Cook Was a Great CEO:

    I had the good fortune of being an intern at Apple, which gave me the opportunity to spend an hour (along with a few hundred of my closest intern friends) with every member of the leadership team, including Jobs and Ive. Cook was, by a significant margin, the most impressive of all of them.

    It’s difficult, in retrospect, to explain why he was so impressive, but I find my struggles eerily similar to the struggles business historians and sociologists have in explaining what company culture is, and why it matters. Tim Cook, at least to my young, rather unjaded eyes, was Apple. He spoke to me – and to every person in the room – as if I were the only person in the world, and that he truly wanted me to understand what made Apple unique. Oh sure, the words were there – he spoke about Apple’s focus, and willingness to say “no,” and about design – but it was the way in which he said it that made you believe. For me anyway, his reality distortion field was far more powerful than Jobs’.

    Today’s presentation – which, make no mistake, had Tim Cook written all over it – reminded me of something else: Cook’s incredible sense of self. Cook is his own man, one of the few in the world who could follow in the footsteps of someone like Steve Jobs without losing himself in the shadow. It’s why Jobs picked him.

    That assuredness and self-confidence was on full display in this presentation. This was Apple, confidently, and without a glimmer of doubt, declaring that the iPhone is special, that it’s worth paying for, and that people all over the world will do just that.

    The strategy, then, is clear. The question remains, of course, as to whether or not it is right.

    First off, this will result in more iPhones sold. I posted this chart Sunday in Thinking About iPhone Pricing (which is worth reading3 if you missed it):

    A "new" iPhone at the same price points as the "old" iPhones will sell many more units due to higher demand
    A “new” iPhone at the same price points as the “old” iPhones will sell many more units due to higher demand

    To the general public, the iPhone 5C is not an old iPhone 5. It’s a new iPhone 5C, and the demand will be much greater than it was for last year’s 4s. The price of a new iPhone is now 16% less than it was last year, and demand should rise by at least that much (and I think most pundits are seriously discounting the attractiveness of color). Moreover, it’s no accident that the traditional closing advertisement was focused on the 5C. I expect the vast majority of ads to be the same, and the iPhone 5C to be the best seller in the line. Sure, it’s not $199 (unsubsidized), but it’s also not $649; to pretend nothing has changed is wrong.

    Second, I expect Apple to move to a dominant position in the US market. iPhone has been gaining share for several years now, and the iPhone 5C at $99 will only accelerate that. I know the US market is special, but it still matters, particularly to Apple and a great number of app developers.

    Third, this solidifies Apple’s hold on the Mercedes-Benz/BMW portion of the Asian market, particularly China. Is it out-of-reach for the vast majority of consumers? Yep. But it will be aspirational, something you put on the table to show others you can afford it. And, to be clear, there are a lot of people that can afford it. Saying stupid things like “the iPhone 5C is equivalent to the average monthly salary in China” belies a fundamental misunderstanding of China, its inequality, and its sheer size specifically, and all of Asia broadly. Moreover, when you consider a Mercedes is tens of thousands of dollars more than a Toyota (and on down the line in luxury goods, for whom Asia generally and China specifically is the largest market by far), $300 more isn’t that much.

    Moreover, in China it’s Apple’s brand that is, by far, the biggest allure of the iPhone. Apps are free (piracy is mainstream), larger screens are preferred, and specs and customization move the needle with the mainstream far more than they do in the US. But no one else is Apple. Having a high price preserves that.

    It is Asia, though, that is ground zero for potential Android-first development. While the 5C will move more iPhones, it will only very slightly slow Android’s massive market share domination, and it’s possible Apple will never break through in any significant way in markets like India or Indonesia.4 Moreover, the Samsung brand is very strong in Asia, and Korean culture as a whole is increasingly dominant; you can’t escape Korean pop, Korean soap operas are the most popular shows continent-wide, and they both include/endorse Samsung heavily. A combination of must-have Android apps and Samsung chic would be problematic.5

    Apple, ultimately, has decided they’re ok with taking that risk.

    As I wrote last week, strategy is about making choices, and Apple has decided to not even pretend to pursue market share, but instead embrace their up-market status. As long as they retain their app advantage, this will obviously be a profitable choice.

    More importantly, it’s Apple doubling-down on what they are best at. I have railed against Blackberry and Nokia for trying to compete in areas they weren’t great at (OSs), instead of focusing on their strengths. Apple is doing just the opposite. They are avoiding a market share fight, which is ultimately about price and compromise, and are instead focusing on the experience of using their products and the advantages accrued by being fully integrated from the chipset to iTunes.

    And that’s why they started with a concert; the iPhone is a brand, an experience, an aspirational lifestyle. Who wouldn’t want to pay just a bit more to be a part of that?

    1. All times are from the official event podcast in iTunes ↩

    2. This is a tried-and-true strategy: iLife moved a LOT of Macs ↩

    3. Of course I think so ↩

    4. They will, however, be in better shape than Google in the aforementioned China no matter what happens; most Android there is Google-less ↩

    5. I don’t really know the European market; I’d suggest Benedict Evans for a better view ↩

  • Twitter Acquires MoPub

    When Yahoo Acquired Tumblr, I wrote about the Signal-to-Ads Cycle:

    The signal-to-ads cycle. Click the image for the original article.
    The signal-to-ads cycle. Click the image for the original article.

    The result is the signal-to-ads cycle:

    • Information is gathered from first-party sites via analytics, 3rd-party sites via ads, buttons, etc, and owned-and-operated mobile apps tied to your identity (think Instagram)
    • Highly targeted ads are served in search results, display ads, and natively, primarily on PCs

    At the time, Yahoo had lots of ads, but almost no signal at all; Twitter had the opposite problem. Great signal, some interesting native advertising, but not many other advertising channels.

    Twitter just filled in a big hole.
    Twitter just filled in a big hole.

    That changed today with the acquisition of MoPub. From TechCrunch:

    MoPub, a startup that helps mobile publishers manage their ad inventory, has been acquired by Twitter, giving the social network another route into building its advertising business, specifically on mobile platforms…

    MoPub as a business works with a number of publishers to help them maximise sales and performance on their mobile ad inventory. For now, it’s unclear whether a Twitter deal would mean that Twitter would become the exclusive customer, so to speak, of this technology, or whether Twitter would use it as a way of branching out its own social graph on to other sites, and other Twitter clients.

    I think it’s very likely MoPub is Twitter’s AdSense:

    • Twitter has a great signal about its users: whom I follow is a great approximation for what I’m interested in. That’s even more valuable than whom I know
    • Twitter is not a great platform for any sort of display advertising; the targeting would have to be much more precise than what is possible with current technology for users to tolerate anything more than promoted tweets

    MoPub solves this riddle; Twitter can serve up highly targeted ads everywhere but Twitter proper. It’s a great acquisition.

  • Thinking about iPhone Pricing

    Before the 5C was well-known, I argued that sticking with just one new iPhone model a year had a dangerous precedent: Ford, and the Model-T:

    Still, the idea that Ford became overly focused on production as opposed to customer needs is a worrying one; if this fall brings nothing more than a 5S, with the same form factor as the 5, well, that will be great for production costs, but not so great for customers who prefer a larger phone, or a cheaper one (and remember, Cook is a production guy, not a product one).

    It was controversial to suggest Apple might add SKUs – heck, it’s still controversial today – even though the logic is inexorable.

    A quick aside about pricing and segmentation

    The most elementary thing to understand about pricing is the demand curve. In general, and as one might expect, the quantity sold has an inverse correlation to price.

    Basic demand curve; as the price drops, the quantity sold increases
    Basic demand curve: as the price drops, the quantity sold increases

    The trouble with only selling one product is that you can only hit one spot on the demand curve; you don’t have a product for customers who fall lower on the demand curve (red in the illustration), and you are charging less than you could to those higher on the demand curve (yellow).

    A one-product strategy is too expensive for some, and doesn't capture full value from others
    A one-product strategy is too expensive for some, and doesn’t capture full value from others

    This is why companies typically sell multiple variations of a product; the idea is to also sell a higher-priced product that appeals to those willing to spend more, and a lower-priced product that attracts those lower down the demand curve. Ideally, the lower-priced product doesn’t cannibalize the higher-priced ones.

    A well-designed multi-product strategy captures much more value
    A well-designed multi-product strategy captures much more value

    In this case, a company can capture much more of the value in the market.

    Apple’s iPhone Strategy Until Now

    Famously, Apple has eschewed segmenting the iPhone’s market. There are lots of reasons this could be the case, but I think the simplest explanation is also the correct one: the iPhone 5 is the first iPhone that Apple believes is “good enough”.

    When a product category is brand new, the first few offerings are always deficient. They’re too slow, too big, missing features, compromised, etc. But, this being technology, the improvement is remarkably rapid. Most of this improvement is at the high-end, but soon it is possible to make a mid-range offering, and then a low-end. However, as long as the market is still immature, the leaps in quality year-over-year are significant and, more importantly, perceptible to average customers.

    In the case of the iPhone, the 3G was clearly better than the 1st iPhone (enclosure notwithstanding), as was the 3GS relative to the 3G, and the 4 to the 3GS. Ultimately, Apple feels it was the iPhone 5 that is “good enough,” as seen by their willingness to finally make a mid-range version.

    If the iPhone 5 is "good enough," then it makes sense to sell a lower-cost version as soon as practical.
    If the iPhone 5 is “good enough,” then it makes sense to sell a lower-cost version as soon as practical.

    The “good enough” threshold is a dangerous one for the integrated innovator, as that is when modular substitutes start to catch up in the overall experience. While the iPhone retains lots of advantages and strong lock-in, to not offer a second, lower (not low) priced iPhone would be a mistake.

    In fact, the primary mistake Apple has made, if they made one, was in determining exactly where the “good enough” line is at. The iPhone 4S is arguably “good enough” and could have been the basis for a mid-range model last year. Apple thought otherwise though; I would imagine a not insignificant factor is that the iPhone 5 is the first iPhone with a fully Apple-designed SoC, the A6.

    Regardless, the line has been set; clearly we won’t see a truly low-priced iPhone until Apple can include iPhone 5-level technology at a price they are comfortable with.

    So What is the Price?

    Given the high bar Apple has set (iPhone 5 technology), I (now1) expect the iPhone 5C’s price to be on the high end of estimates, and possibly higher.

    The fact the 5C needs to be sold in both subsidized and unsubsidized markets makes the pricing tricky; in subsidized markets, Apple is currently receiving a subsidy of around $450 on the iPhone 5. It wouldn’t make sense to unilaterally lower that – after all, it’s not like the carriers are going to lower iPhone service bills. This sets a floor of $450 for the unsubsidized 5C ($0 with contract). This also lets Apple dump the 4S, with its 3.5″ screen, 30-pin connector, and lack of LTE.

    $0, though, is problematic from a branding perspective. While a new phone, heavily advertised (unlike the old iPhone 4) and sold for $0 would move an incredible number of units, it would also create consumer expectations around $0 and associate Apple with “cheap.” I would imagine Apple is very hesitant to go there. $99 makes more sense. (This point on branding applies to the unsubsidized cost as well; in Asia, in particular, the iPhone’s biggest selling point is brand prestige, not apps or user experience. Apple will be happy to err on the side of more expensive.)

    $99, however, implies an unsubsidized cost of $550. While certainly cheaper than the 5S, it’s not clear that $100 delta is worth the additional complexity of an entirely new phone.

    In other words, to answer this section’s heading, I’m still not sure. Something has to give, whether it be the subsidy amount, avoiding the brand association with $0, or a too-high price. I’m leaning towards a lower subsidy, meaning a price of $450/$99;2 that may also be why NTT DoCoMo and China Mobile will finally sell the iPhone. Still, I wouldn’t be surprised at $450/$0. (Update: I’m hearing $550/$99 has a good chance, but totally unconfirmed).

    How is This Strategy Different?

    It is true that Apple has been selling multiple iPhones for a few years now; right now they sell the iPhone 5 for $650/$199, the iPhone 4S for $550/$99, and the iPhone 4 for $450/$0. However, while this does capture some customers further down the demand curve, I think that the overall demand for “old” iPhones is much lower than demand for “new” iPhones.

    "Old" iPhones likely have less overall demand than "new" iPhones
    “Old” iPhones likely have less overall demand than “new” iPhones

    The 5C, on the other hand, will be about as “new” as an iPhone can get, particularly with it’s colorful enclosures. Even if it’s priced the same as an iPhone 4S or 4, it will sell many, many more units because of stronger demand.

    A "new" iPhone at the same price points as the "old" iPhones will sell many more units due to higher demand
    A “new” iPhone at the same price points as the “old” iPhones will sell many more units due to higher demand

    I expect the 5C to be a massive hit, not just internationally, but also in the US and other subsidized markets. This suggests a significant drop is the iPhone average selling price, but a big bump in top line revenue. The margin impact isn’t clear; iPhone 5 internals sold at $450 will likely cause a decent, but not huge, dip.

    What about the iPhone 5S?

    The 5C clearly targets two iPhone growth opportunities: unsubsidized markets, and price-sensitive customers in subsidized markets. However, there is one other huge opportunity that Apple has always been reticent to target: enterprise.

    The implosion of RIM and fragmentation of Android are increasingly leaving the iPhone as the default choice of more and more enterprises, and it’s in this light that the rumored fingerprint sensing technology is particularly interesting.

    Most corporate laptops require two-factor identification. Previously, this meant a key card, although most now use the TPM chip with a separate password. Phones have been managed; IT departments can require a strong password, and remotely wipe a device, but there is no way to do 2-factor authorization, even though smartphones are just as much a computer as the laptops used 5 or 10 years ago.

    In this light the fingerprint scanner is very useful: a fingerprint + password = 2-factor authentication. I could absolutely see the 5S being the first Apple product to not just infiltrate the enterprise from the ground up, but to be actively encouraged and even required by IT departments.

    For this reason, I don’t think the 5C will have the scanner; even Apple will do something to protect their high end.

    1. I previously argued rather stridently that the iPhone 5C ought to be very aggressivly priced, although even then I was struggling with the subsidized versus unsubsidized pricing problem, and quickly changed my mind. I do think that Apple has been slow in moving the iPhone to lower price points, and are suffering for it particularly in Asia. Perhaps I’ve been influenced too much by what I see, but there’s no question there are fewer iPhones relative to Android here in Taiwan than there were two years ago. Still, it really would have been out of character for Apple to be that aggressive; it increasingly seems the iPod, which was always price-competitive, was more of an aberration ↩

    2. In this case, the 4S stays at $0 subsidized. Regardless, in all cases I think the 5 will be discontinued ↩

  • Shameless Samsung

    Samsung introduced the Galaxy Gear yesterday, and, yeah, it’s not great.

    I jumped on the leaked prototype, with the same general sentiment: Samsung’s watch will undoubtedly change drastically whenever Apple’s wearable is released. And, to be certain, we will mock them for copying.

    Perhaps we’ll even use a staged picture:

    Or maybe just a checklist:

    Samsung, to their credit, hasn’t responded; if I ran their Twitter account, I’d be tempted to post this:

    Via Benedict Evans. Click the image for the original article.
    Via Benedict Evans. Click the image for the original article.

    Every pre-iPhone phone maker is irrelevant, if they even exist, except for Samsung, who is thriving. Samsung the copycat was smart enough to realize they needed to change, and quickly, and so they did.

    Or maybe it wasn’t being smart. Maybe it was simply not caring what anyone else thought about them, their strategy, or their inspiration. Most successful companies, including Apple, including Google, seem remarkably capable of ignoring the naysayers and simply doing what is right for their company. In the case of smartphones, why wouldn’t you copy the iPhone? Nokia refused and look where that got them!

    We, especially in the West, have a powerful sense of justice and fairness when it comes to product features and being first. Business, though, is not fair, even if it is more just than we care to admit.

    Notification: You will be discontinued when Apple releases a wearable.
    Notification: You will be discontinued when Apple releases a wearable.

    Ridiculous? Yes.

    Probability of failure? High.

    Discontinued after Apple’s launch? Certainly.

    Liable to put Samsung out of business? In fact, it’s a symbol of exactly why they succeed.

  • Another Nokia Explanation; The Same Tragic Conclusion

    While I remain convinced that Microsoft’s Nokia acquisition was largely driven by fear of losing Nokia as an OEM, either to Android or bankruptcy, there is something else curious about the timing.

    (The following scenario is conjecture, but not the analysis that follows)

    ValueAct, who is opposed to Microsoft’s push into devices, was dissuaded from a proxy fight last Friday (the last day to file their intentions). The price? Steve Ballmer as CEO.

    However, they don’t join the board for another month. And so, Ballmer and the board, fully committed to becoming a devices company, pushed through the Nokia acquisition (ValueAct had no idea), locking in the devices and services strategy (and the reorg to a functional organization).

    Shades of the old Microsoft, to say the least.

    In this version of the story, Stephen Elop is almost certainly the next CEO; this telling presumes that the Nokia discussions proceeded in tandem with the reorg, with the presumption Elop would take over a functional organization in 2018, Ballmer’s original retirement date. Now that will be pulled forward.

    That’s the tell, in fact. Will Elop be CEO? If my original theory is true – that Nokia was on the verge of leaving Windows Phone, either for Android or bankruptcy – then Elop simply can’t be a serious candidate.

    This version of the story is, of course, much friendlier to Microsoft. It’s always better to be portrayed as being Machiavellian as opposed to being helpless. My conclusions, though, remain the same:

    The tragedy in the deal, as I hinted at earlier, is that I think Microsoft ought to abandon Windows Phone. The war is over, and iOS and Android won. It would be far better for Microsoft to focus on serving and co-opting those devices, instead of shooting the most promising parts of their business in the foot for the sake of a platform that is never going to make it.

    Let me elaborate on what I mean:

    • The problem for Microsoft in mobile is that Android has completely destroyed the value of a licensed OS; Microsoft’s traditional software model is broken. The only way to make money is to sell hardware to a segment of the market (with lower margin percentages relative to software), or services that sit on top of OSs (with lower prices relative to software).

    • A services model is horizontal; a devices model is vertical

      Devices are vertical, services are horizontal
      Devices are vertical, services are horizontal

      If your strategy is services, like Google, then you seek to serve every platform. If, on the other hand, your strategy is devices, then you seek to differentiate your platform alone

    The issue for Microsoft is that a services strategy and a devices strategy are fundamentally opposed to each other. Your services will be forever paying a strategy tax to support your devices, which won’t even be fully differentiated.

    You see this happening right now with Office. Microsoft has to date refused to release Office for iPad, presumably to help make Windows 8 a tablet success. On the flip side, there is finally a version of Office for iPhone and Android, which removes a key Windows Phone differentiation. It’s a mess.

    If you believe that strategy is about making choices, then it’s clear that “Devices and Services” isn’t a strategy at all.

    Yet, it now seems highly likely that this “strategy” will be put into effect, which in practical terms will mean the continued hamstringing of Microsoft’s services to support their push into devices, magnified by the “One Microsoft” reorganization.

    And that’s too bad.

    Microsoft has some great services up-and-down the stack, and Office 365 in particular is remarkably innovative from a business model standpoint, and a much better product than critics like to admit. Microsoft ought to have their entire weight behind protecting their business turf and winning in the cloud and premium consumer services.

    Moreover, it’s a much better fit for whom Microsoft is as a company. They are not “One Microsoft,” and have not been for decades now. Instead they are a company with a bunch of products and divisions who primarily share an insatiable thirst to win everywhere, enemies and friends be damned. They ought to pursue a strategy – services – that entails just that: being everywhere. Unfortunately, they now have $7 billion more reasons and the distraction that comes with them to pursue a strategy that they themselves see as winning only 15% of the market.1

    As someone who wants to see Microsoft succeed (or at least not fail), for the sake of my many friends who work there and the Seattle area as much as anything else, it’s disappointing. Alas, it’s not surprising.

    1. Clearly, Microsoft can’t let go of their OS fixation – and this includes Elop. Moreover, I think their Internet Explorer victory in the 90s has fooled them into thinking they have a chance today. The problem is that web pages (theoretically) work anywhere; apps don’t ↩