Wearables, Payments, Chickens and Eggs

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I feel a bit sheepish that this is the third of what will in all likelihood be four articles about Apple in a two-week span. I figured the scale of what Apple is planning to announce necessitated at least two preview posts; one about the iPhone and this one about wearables and payments. And then the iCloud theft happened, and well, here we are.

At the same time, it’s difficult to overstate the broad impact that Apple has on the entire tech ecosystem, whether it be establishing categories it competes in directly or in fundamentally changing assumptions in others impacted by their wake (think the rise of mobility as a critical component of enterprise software). Moreover, it’s not as if these articles won’t be read; any blogger with access to their Google analytics panel knows that anything Apple moves the needle in a way few other topics do.

Apple, of course, knows this as well, and what is so interesting about how they are approaching wearables and payments – together – is the way in which they are leveraging their popularity to make something that could not otherwise come into being.

The Problem With Payments

I discussed the challenge of introducing new payment methods in April in a post called The Problem with Payments:

  • You can get more adoption by building on top of credit cards, but that leaves almost no room for any sort of meaningful profit margin. This is Square’s fundamental problem
  • Building outside of credit cards gives you more room to maneuver from a profit perspective, but the delta of improvement between your new solution and credit cards is likely much too small to overcome the double-sided network effect credit cards enjoy (merchants and customers)

The rumors about Apple using the iPhone 6 for payments seemingly faces both of these challenges:

  • Any Apple payment solution will almost certainly be built on top of their current collection of 800 million credit cards, which means there won’t be much if any money to be made
  • The delta of improvement between pulling out your phone and pulling out your credit card may not be big enough to make a difference. It certainly hasn’t moved the needle for Android, even in countries like Japan that have invested significantly in NFC infrastructure. And, if customers won’t bother, neither will merchants

What is needed is something a lot better than a physical credit card and a critical mass of people willing to give it a try.

Enter The Wearable

People often mock any new Apple product by pointing out that, “Sure, the diehards will buy whatever Apple releases” before insisting that said product will never have broad appeal. We saw it with the iPad, the iPhone, and the iPod, and we’ll almost assuredly see it with the wearable. And, when and if people complain that only Apple fans will buy the wearable, Tim Cook and company are liable to nod their heads, knowing that that’s the point.

There is the age-old question: “What came first, the chicken or the egg?”, and it’s one that is brought up again and again when it comes to building an ecosystem. For example, the biggest problem with Windows Phone is the lack of top-notch applications, but the reason that developers don’t prioritize the platform is that there aren’t enough valuable users, but there will never be enough valuable users until there are top notch applications. It’s a chicken-and-egg problem.

As I noted above, the same problem exists in payments: merchants won’t support a new payment method unless lots of valuable customers insist on it, but said customers won’t insist on a particular payment method unless lots of merchants support it.

That’s where Apple’s ability to move units simply because they are Apple becomes something that is an incredible weapon: suppose 10% of iPhone customers are willing to buy a wearable with some cool fitness functionality mainly because it’s built by Apple. Boom – suddenly there are 80 million wearables with payment functionality out in the wild.1 Moreover, the customers sporting said wearable are likely to be both vocal about their desire to use said payments, and high spenders to boot. That’s a very good way to spur merchants to install what will likely be a free payment device, available at your local Apple Store. Of course it wouldn’t hurt to move the process along by having partnerships already set up with Nordstrom and Target.2

Moreover, I’d bet the difference between using a wearable for payment and using your phone will be greater than most people expect. I have no particular evidence for this outside of my own experience with keyless ignition systems in cars; the first time we got it, I thought it was a tremendous waste of money (it was part of a package); since then, I can not imagine buying a car without it. Saving a bit of hassle and a few seconds on a daily basis really adds up; it’s the type of subtle experience improvement that is Apple’s biggest differentiation.

Not Just Payments

This idea – that Apple, simply by being popular, can get past the chicken-and-egg problem – applies to HomeKit as well. If we have keyless ignition in cars, why not keyless locks, automatic air conditions, or lighting? There is a whole host of items that could work well with a wearable, but that would only be built if there were a critical mass of wearables out there.3

More broadly, this is the answer to the question of why build a wearable at all. It’s easy to see a future where a wearable is the center of an entire ecosystem of devices and services; what’s hard is seeing how on earth we get from here to there. Unless, of course, customers give the device critical mass simply because it is made by Apple (even though they’ll tell themselves they buy it for their health).

Apple has a better chance than anyone of creating a critical mass of users for a new payment system.
Apple has a better chance than anyone of creating a critical mass of users for a new payment system.

Let me be perfectly clear: while most of those who argue that any Apple product will sell just because of the logo mean that as an insult, I’m saying that’s actually a really unique ability that only Apple has. Remember this line in the Cook Doctrine:

We participate only in markets where we can make a significant contribution.

Apple, not only because of its product capability but also because of its incredible customer loyalty, is uniquely suited to solve the payments chicken-and-egg problem and provide the killer use case for a wearable, all at the same time.

What’s In It for Apple?

Contrary to the expectations of some Apple bulls, I don’t think Apple has any interest in getting into financial services. I suspect they will be quite happy to sit on top of traditional credit cards, just as the iPhone sits on top of traditional carriers. In fact, when it comes to making money Apple’s strategy is remarkably straightforward: they sell devices for a profit; their services and infrastructure serve primarily to differentiate said devices.

That is why I expect Apple to offer payment terminals to merchants for free or close to it, and to not charge any surcharge beyond what is necessary to cover credit card fees. Their payoff will be in the creation of a killer wearable use case, something that will ultimately benefit Apple as a wearable seller more than anyone.

It will be fascinating to watch if Apple can succeed, and, if they do, what will happen to the companies in their wake. Just as the iPhone ultimately shook up all kinds of industries, including enterprise software, a true payments breakthrough will not only be the end of a whole raft of startups but could also have significant impact on all kinds of related industries. I suspect, though, all that matters to Apple is making life that much better for that many more people, something that is not only true to their mission but also results in a formidable strategic tool as well.

  1. Presuming an install base of 800 million iOS devices, which was the number reported at WWDC ↩

  2. So says not one but two little birdies ↩

  3. A wearable could also be the best possible answer to the password problem: a wearable alone is likely more secure than a password, and a wearable plus TouchID is likely the most consumer-friendly two-factor authorization possible ↩

Podcast: Exponent Episode 016 – Naked People

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On the newest episode of Exponent, the podcast I co-host with James Allworth:

In this week’s episode we discuss James’ first ever trip to Burning Man, ugliness in modern culture and on the Internet, the new divide in politics, and ultimately why we have hope for the future.

Links

  • Grover Norquist: My First Burning Man: Confessions of a Conservative from Washington – The Guardian
  • Devin Faraci: Why I Feel Bad For – And Understand – The Angry #GamerGate Gamers – Badass Digest

Listen to the episode here

Podcast Information: Feed | iTunes | SoundCloud | Twitter | Feedback

iCloud and Apple’s Founding Myth

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From a certain perspective, what is happening to Apple this week is unfair. Both OS X and especially iOS are more secure than their competitors, and Apple has regularly prioritized security over features that customers have demanded. For example, Android has long supported custom keyboards, but Apple is only adding them in iOS 8. The difference, though, is that Apple’s solution makes it impossible for the substitute keyboard to be a keylogger sending the keys to another server (without explicit user authorization), and can’t be used in secure password fields at all. No such limitation exists in Android.

On the other hand, Apple very much deserves all of the terrible publicity they are getting. Even if the vast majority of photos were stolen through means like password resets, phishing, and social engineering, the reality is that Apple’s reservoir of goodwill when it comes to the cloud is deservedly empty. And, having bugs like a missing rate limiter, or recommending that people use two-factor authorization that wouldn’t have actually helped, only makes the distrust worse.

I think the most useful way to understand Apple’s troubles with the cloud is to think about the A-series chips. Jonathan Goldberg described why making chips is so difficult in a recent blog post:

Designing hardware is much harder than designing software, and by ‘hard’ I really mean expensive. If you design a web site, the whole product can be built around the idea of iteration. The first version will not work perfectly, so plan for that, and fix it in upgrades. And upgrades on the web or in the cloud are very easy. In hardware, everything has to be right before you ship the product. And not just before you ship, but really before you even start to build it. Returns are prohibitively expensive, and hardware cannot be readily fixed on the fly or in the field. This problem is even more acute in semiconductors. First, those chips have to get designed into other things, and that means even longer preparation times. Secondly, the complexity of the semiconductor manufacturing process are hard for the human mind to grasp. The industry requires incredibly tight specifications, as you can imagine for circuits many times smaller than a human hair.

It turns out, though, that Apple is really good at designing chips! The A7 is still the only 64-bit ARM processor on the market, and Apple looks likely to extend their lead with the presumed A8 in the iPhone 6. Still, the process of making a semiconductor – or hardware generally – is very clearly in Apple’s DNA. Just think back to the original Macintosh. From the invaluable Folklore.org:

The Mac team had a complicated set of motivations, but the most unique ingredient was a strong dose of artistic values. First and foremost, Steve Jobs thought of himself as an artist, and he encouraged the design team to think of ourselves that way, too. The goal was never to beat the competition, or to make a lot of money; it was to do the greatest thing possible, or even a little greater…

Since the Macintosh team were artists, it was only appropriate that we sign our work. Steve came up with the awesome idea of having each team member’s signature engraved on the hard tool that molded the plastic case, so our signatures would appear inside the case of every Mac that rolled off the production line. Most customers would never see them, since you needed a special tool to look inside, but we would take pride in knowing that our names were in there, even if no one else knew.

To me this is one of the defining “founding myths” of Apple,1 and founding myths are really important. They define culture, and what is important and valued, and in the case of Apple, what is valued is creating the “greatest things possible” through an effort that most customers will never see.

Other companies have founding myths too:

  • Google’s founding myth is the creation of BackRub and PageRank. These were highly iterative projects that got better the more they were used. This myth created a culture that values iteration and data
  • Microsoft’s founding myth is Bill Gates and Paul Allen selling both Altair BASIC and Windows 1.0 without an actual product. They built exactly what their customers needed after making the deal, and Microsoft’s culture has always been very responsive and heavily influenced by customer requirements
  • Facebook’s founding myth is Mark Zuckerberg in his dorm room creating a means of connecting with other students through any means possible. Even today Facebook highly values “hacking” and constantly changing things to ever more highly engage users

I’m painting with broad strokes to be sure, but to me the most compelling evidence for these founding myths is to look at the sort of products that these companies have traditionally been bad at:

  • Facebook has been a rough go for developers, because hacking and breaking stuff doesn’t make for a good platform
  • Microsoft has always struggled with consumer software, because building for a the mass market requires having an innate understanding of what the majority needs, not simply asking them
  • Google’s products don’t always have the best fit-and-finish, because the tendency is to make something that is “good enough” and ship as soon as possible, the better to start iterating

And, for Apple, making something perfect behind closed doors is the exact opposite sort of approach that is needed for the cloud. Effective cloud services are all about iteration based on data from usage – the Google model – and that’s not the sort of approach that Apple values.

This also applies to security generally. Apple has a much greater degree of control over the attack vectors on its operating systems; when it comes to Internet services, on the other hand, the number of attack vectors are exponentially larger. You need a lot of people helping you harden your infrastructure, but that requires transparency, and that’s not something Apple values.

It’s important to be clear about who exactly is to blame for this theft: the thieves. But stepping back, there is a bigger problem with Internet security generally, and that’s our reliance on passwords. Passwords are really difficult to manage even for advanced users; for normal folks it’s a real nightmare.2 That’s why Apple and other services include things like security questions to help you get into your account, even though that makes the account even more insecure. There is a fundamental tradeoff between security and ease-of-use, and that too works against Apple here; their entire differentiation is predicated on the user experience, and not having backup-by-default or enforcing two-factor authentication is counter to that, even if it would be more “secure”.

It’s here, though, that Apple has gone the farthest down the road towards fixing what seems to be an intractable problem: TouchID. TouchID works really well, and it removes the temptation to have a simple password on your phone or for your Apple account. When and if Apple has Touch ID everywhere – on iPads and on Macs3 – it would be much more plausible for them to enforce very strong passwords, encryption everywhere, two-factor authorization, etc., because most people would just use their fingerprint most of the time.

Moreover, TouchID is something that is very Apple-esque, for lack of a better term. It’s something that is hardware-based, and it requires incredible attention to detail on both the implementation and experience. It’s not something that lends itself to a minimum viable product + iteration approach; instead it depends on deep integration of hardware and software – Apple’s forte.

The problem, though, is that TouchID isn’t there yet. We’re still in the world of passwords and security questions, and while Apple has often let problem issues fester until they can come up with something perfect – think copy-and-paste or multitasking in iOS – that sort of approach is irresponsible when it comes to the cloud. This break-in may not ultimately be Apple’s direct responsibility, but the lack of trust so many have in anything related to Apple’s cloud is.4

There’s no question the cloud is critical to Apple’s future and is a major piece of the iPhone value proposition; from a strategic perspective it is core to Apple. But Tim Cook needs to seriously evaluate if Apple has or ever will have the cultural DNA to do the cloud right. And, if not, it may be time to work even more closely with a company whose very survival depends on delivering superior cloud services; I’m quite sure Satya Nadella would answer the call.

  1. Yes, I know the Macintosh was not even close to being the first Apple product, and that the Apple II made most of the money for years after the Macintosh came out. However, to my mind it was the Macintosh that laid the foundation for what Apple stood for ↩

  2. Anecdotally, multiple Stratechery members request a password reset every week, and that’s for a more technically inclined audience ↩

  3. I’m generally skeptical of the whole OS X on ARM argument, but Touch ID and its secure enclave are an argument in favor ↩

  4. Honestly, the rate limiter bug – whether or not it had anything to do with this specific theft – was grossly negligent ↩

The iPhone 6: From Louis Vuitton to Chanel

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Yves Carcelle, who, in the words of the New York Times “transformed Louis Vuitton from a staid French maker of handbags and travel trunks into one of the world’s most recognizable luxury brands” died over the weekend. I have a short note in today’s Daily Update (members only) that compared Louis Viutton to Apple:

LVMH broadly and Louis Vuitton specifically democratized luxury with a clear focus on the (upper) middle class. It’s the same market Apple targets, with much the same value proposition: luxury quality at accessible prices. To be sure, the comparison isn’t perfect; LV bags are both more expensive than, say, an iPhone, yet also not even close to being the best in their category, and many people believe that LV has overly expanded – and thus diluted – its brand. Of course that is always a concern for Apple as well.

It’s the second point – how LV’s position in the market differs from Apple’s – that is particularly worth exploring when it comes to next week’s iPhone announcement.

Last year all of the talk running up to the iPhone announcement was about the iPhone 5C and how much it might cost. In Thinking About iPhone Pricing, I argued that the price would be on the high side of expectations:

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 likely 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.)

This final point about the iPhone’s positioning in Asia was a reference to the idea of a Veblen good. From Wikipedia:

A Veblen good is a member of a group of commodities whose demand is proportional to their price; an apparent contradiction of the law of demand. A Veblen good is often also a positional good.

The Veblen effect is named after economist Thorstein Veblen, who first identified the concepts of conspicuous consumption and status-seeking in 1899.

Conspicuous consumption and status-seeking are major drivers of the Asian market in particular, and are why Asians make up over 50% of the luxury market by nationality.1 In the case of handbags, you absolutely are saying something with your selection: a Louis Vuitton bag is many people’s first luxury purchase, and shows you have some means; a Chanel bag, on the other hand, signifies you are at least upper middle class, maybe even rich. At the top of the heap, though, is Hermès: sport a Birkin bag and there is no question as to your status. A whole host of other brands – Prada, Céline, Balenciaga, and many more – say similar things about not just your status but also your taste and the kind of person you wish to be. And, not surprisingly, the most desirable brands are also the most expensive. Handbags are Veblen goods.

The question for Apple is whether the iPhone is a Veblen good as well:

  • There is no question that the market for smartphone has bifurcated. There is a high end with a stable average selling price of around $650; the iPhone has a significant majority here, but there are also phones from Samsung, HTC, LG, and others. The rest of the market competes primarily on price, and very good Android smartphones can be had for prices approaching $100. The middle of the market, meanwhile, is supported primarily by $0 subsidized phones and, to a lesser degree, demand for older iPhones.
    The smartphone market has bifurcated between the high and low end. The low end is motivated primarily by price.
    The smartphone market has bifurcated between the high and low end. The low end is motivated primarily by price.

  • On the high end (say, $450 and up), the evidence actually suggests that people strongly prefer higher prices. Consider the 5S’s success relative to the 5C, or the fact that Samsung and HTC still launch their flagship phones at $650. Now, to be fair, there are two countervailing factors at play:

    • The more expensive iPhone is better, so this is an apples and oranges comparison
    • The prices of all these phones are influenced by the subsidy structure of the U.S. market in particular

    That aside, just as I argued last year that Apple didn’t really know the price elasticity of the iPhone, they don’t really know just how much people are willing to pay to have the best possible model. It’s at least worth finding out just how much the market can bear.

    For a normal good, the quantity increases as the price decreases. A Veblen good, though, curves in the opposite direction.
    For a normal good, the quantity increases as the price decreases. A Veblen good, though, curves in the opposite direction.

And so, in a very long and roundabout way, we have arrived at what I think is the more interesting of the two rumored iPhone models: the 5.5″ iPhone 6. I believe the phone does exist (some don’t) for no other reason than Apple would have planted a leak if it didn’t; they surely know how devastating its absence would be in certain segments of Asia in particular.

Make no mistake: there are a good number of people who will buy the 5.5″ iPhone because they truly want a big phone; moreover, these customers are probably more likely than any other group to have switched to Android simply for screen size. I think this phone will steal customers back from Android and really hurt Samsung.

However, I also think that this phone will cost $100 more ($750 to start), and that it will in some small ways be superior to the 4.7″ iPhone. And, the reason for that premium will be because the 5.5″ phone will be a Veblen good. It will be the phone to have for anyone who cares to demonstrate just how well-off they are, especially in Asia – the Chanel to the 4.7″ Louis Vuitton (Vertu can keep the Hermès folks).

There is one more fact that makes this strategy compelling: your average Chanel bag is $4,000 (compared to LV’s $2,500 or so). That is more than 5x the price I’m predicting for the 5.5″ iPhone. As I’ve noted previously absolute numbers matter just as much if not more than percentages, and the truth is paying $750 for the best is incredibly accessible relative to just about any other luxury good in the world. Sure, lots of folks even in China may not afford Chanel, but anyone who can afford even a Longchamp bag can buy the best iPhone. It’s a rather nice trick Apple has pulled: being accessible and the best of breed all at the same time.2

I expect the rest of the phone lineup to fall into place behind the 5.5″ flagship:

  • The 4.7″ iPhone will take the 5S’s place at the $650 price point ($199 subsidized). I suspect it will have the same processor, RAM, and camera as the big iPhone; Apple will market it as being completely the same except for the screen (I suspect John Gruber is right that the 5.5″ will have a 3x display, while the 4.7″ will have only 2x)
  • The 5S will move down a notch into the current 5C slot and be sold for $550 ($99 subsidized)
  • The 5C will be the low end with a price of $450 ($0 subsidized)
  • The 4S will probably stick around in select markets like India and China for $350, but Apple is probably waiting for the 5C to move down one more notch before they really push this price point

This is an incredibly compelling lineup from a shareholder perspective:

  • More people are on the new form-factor upgrade cycle than on the ‘S’ upgrade cycle
  • New screen sizes are a very tangible reason to upgrade for those who have kept their phones longer than average
  • Selling the top-end phone for $100 more will be a big boost to both the average selling price and to margins.

This last point is Apple’s final answer to those still holding out hope for a truly inexpensive iPhone. Apple could:

  • Sell a $300 phone with a $100 margin (and likely cannibalize a higher-end model with bigger margins), or…
  • Substituted a $750 phone for a $650 phone for the same $100 margin addition3

It’s a bit like how the iPhone cannibalized the iPod: by being more expensive and higher margin. Nice business if you can get it!

(Later this week: wearables and payments)

  1. Figures are from this presentation by Bain; note that Asia as a geography is only about 33% of the market. Most of the difference is accounted for by Asian tourists traveling to Europe in particular ↩

  2. Don’t pay any attention to stats about the average wage in China; the country is both huge and has massive income disparity, which means there are a huge number of people who can afford whatever Apple deigns to charge. More here  ↩

  3. Minus the additional cost of the superior components, of course ↩

Podcast: Exponent Episode 015 – Consoles and Disruption

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On the newest episode of Exponent, the podcast I co-host with James Allworth:

In this week’s episode we discuss whether or not consoles will be disrupted. This episode was recorded a week ago (immediately after last week’s episode), before Ben wrote his pieces Games and Good Enough and Games and New Market Disruption.

Links

  • Ben Thompson: How Apple TV Might Disrupt Microsoft and Sony – Stratechery
  • Ben Thompson: Games and Good Enough – Stratechery
  • Ben Thompson: What Clayton Christensen Got Wrong – Stratechery
  • Ben Thompson: Gaming and New Market Disruption – Stratechery
  • Medallia Receives $50M in New Funding to Meet Growing Market Demand for Software that Makes Companies More Customer Centric – Medallia

Listen to the episode here

Podcast Information: Feed | iTunes | SoundCloud | Twitter | Feedback

Podcast: Vector – Turtles All the Way Down

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I joined the Vector podcast to talk about Apple University, Microsoft stack ranking, patents, Samsung copying, iPhone screen sizes, native advertising, and a whole lot more. I think you’ll enjoy this one.

You can listen to the episode here.

Amazon: Not an E-commerce Company

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Let’s start with the premise that Twitch, the video-game watching network, is the next ESPN – you know, the jewel in Disney’s crown that, by itself, is worth $50.8 billion. Like ESPN, Twitch is about live competition, and, like ESPN, Twitch does exceptionally well in the highly desirable young male demographic.1 Obviously this is the best possible outcome, far-fetched though it may sound. It is certainly an outcome that would make Amazon’s purchase of Twitch for $970 million an amazing deal. It would not, however, have anything to do with e-commerce.

Just a few weeks ago I wrote in Losing my Amazon Religion about Amazon’s focus on Prime Video in particular:

It’s this focus on original and exclusive content – and devices that deliver it – that concerns me, and not because it’s expensive. Rather, what exactly does this have to do with e-commerce?

Needless to say, the Twitch acquisition hasn’t exactly quelled my concerns. It has, though, led me to question my premise; if Amazon is behaving, shall we say, erratically, the issue is perhaps not with Amazon but with my understanding of the company. So I went back and reread the origin story of Amazon in Brad Stone’s excellent The Everything Store:

[John] Doerr’s optimism about the Web mixed with Bezos’s own bullish fervor and sparked an explosion of ambitions and expansion plans. Bezos was going to do more than establish an online bookstore; now he was set on building one of the first lasting Internet companies.

Over the following pages Stone documents how Amazon expanded from books to music and then to DVDs. These categories, along with packaged software (including games) eventually made up the “Media” category in Amazon’s earnings. Today this media category is about 25% of Amazon’s revenue, but, according to my understanding, almost all of Amazon’s “profits.” Said profits are reinvested into all the other parts of Amazon’s business, but, it must be asked, to what ends? Is Amazon really an e-commerce company? Or are they a company bent on dominating the world?

Returning to Twitch, I can think of three possible reasons for Amazon’s purchase:

  • Amazon is looking to buttress their media business – That Media business that underpins the Amazon machine is not in the best of shape; traditional media forms are going away, and, except for books, Amazon does not have a ready-made replacement from a revenue standpoint. In this view, Twitch offers a new revenue model (ads, primarily, although there are also premium subscriptions) that can help fill this gap.

  • Amazon wants to challenge Valve and/or Sony and Microsoft – I think this is a very underreported aspect of this deal. Steam in particular has taken a significant bite out of Amazon’s packaged software business, and I know that Amazon has at least internally considered building a direct challenger. Amazon has also included gaming capability into the Fire TV, including an optional controller, and has bought their own gaming studio, basically following the script I laid out in How Apple TV Might Disrupt Microsoft and Sony. However, as I insinuated in Gaming and Good Enough, hard core gamers are very unlikely to so easily abandon the established players. In this view Twitch is a backdoor way to “get in” with hardcore gamers; imagine a Fire TV built around Twitch and Amazon’s own games.

  • Amazon wants to rule the world – I put it this way only partly in jest, because I’m starting to suspect this is a bigger factor than anyone – including Amazon’s everpatient investors – fully appreciates. Remember, Bezos sold books not because he was obsessed with being a bookseller, but because he identified a dominant strategy; as Stone’s book suggests, perhaps Bezos’s goal was simply to build a dominant company, and e-commerce has only ever been a means to an end.

The second reason, that this deal was about gaming, is interesting from a tactical perspective, but the far more intriguing question is the weight one gives to reasons one and three. If you buy reason three – that Bezos wants to rule the world – then there is even more urgency attached to reason one. To be clear: Amazon’s continued expansion is built on the profits from its media category, but it is that category that is the most under threat from the digitalization of said media. In other words, what if Twitch is both offense and defense?

Regardless, the takeaway for me – and what should be the takeaway for all of Amazon’s investors – is that Amazon is not an e-commerce company. No more pointing at the fact that e-commerce is only 6% of U.S. retail, or that Amazon’s multi-sided network of merchants and customer base are the key factors in determining their future success. No, the company is going for something a whole lot bigger, even as their foundation is being slowly watered down by the same Internet that made Bezos feverish nearly 20 years ago.

  1. Twitch’s video game playing “athletes”, though, peak far earlier than professional athletes according to this fascinating article in The Verge ↩

Gaming and New Market Disruption, and the Week in Daily Updates

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The main page content on Stratechery is free for all readers, but I also offer the Daily Update via email and RSS for $10 per month/$100 per year. This is one of the items sent out in this week’s Daily Updates. To read all of the Daily Updates, visit the Membership page

The fastest growing demographic in gaming is adult females. From the Wall Street Journal:

Female gamers made up about 48% of the game-playing public in the U.S. this year, according to a report recently published by the Entertainment Software Association, a U.S. game industry trade group. That is up sharply from 40% in 2010. What is more, women over 18-years-old now represent a significantly larger portion of the U.S. game-playing population than boys under 18, a demographic that has traditionally been seen as a core target group for game companies. The ESA based its findings on a study of 2,200 U.S. households.

A recent survey from Nielsen Holdings NV, a U.S. consumer research company, concluded that women gamers in the U.S. are most likely to play games on personal computers, mobile devices and Nintendo’s Wii console. In fact, U.S. women are more likely than U.S. men to play on the Nintendo Wii, Nielsen said, while they are equally likely as men to play games on Apple devices…

The growing number of female gamers largely comes down to a surge in so-called casual mobile game, a genre of games boosted by the fast adoption of smartphones, executives from game companies say.

So, to sum it up, mobile and casual gaming, dismissed by traditional gamers, are in fact growing hugely. Ben, you were wrong to change your mind about whether or not consoles would be disrupted!

Not exactly, and I think I should have been more clear on this specific point: I believe that mobile and casual gaming, if it is disruptive, is a case of “new market” disruption, not “low-end” disruption. Clayton Christensen first defined these two terms in The Innovator’s Solution:

There are two different types of disruptions, which can best be visualized by adding a third axis [to performance and time]…The third dimension that extends toward us in the diagram represents new contexts of consumption and competition, which are new value networks. These constitute either new customers who previously lacked the money or skills to buy and use the product, or different situations in which a product can be used – enabled by improvements in simplicity, portability, and product cost…

We will refer to disruptions that create a new value network on the third axis as new-market disruptions. In contrast, low-end disruptions are those that attack the least-profitable and most overserved customers at the low end of the original value network.

In other words, if I made an error in comparing iOS/Android to mobile gaming/consoles, it was in conflating low-end disruption (i.e. cheaper, modular Android theoretically disrupting the iPhone) with new market disruption (i.e. casual mobile gaming theoretically disrupting dedicated gaming devices). Clearly anything mobile-related is a perfect example of a “different situation in which a product can be used.”

Still, though, the point I was trying to make was not that Android won’t take up the majority of the market (obviously false) or that mobile gaming won’t do the same (it probably will); rather, I dispute the assumed end game. Again from the Innovator’s Solution (emphasis mine):

Once the disruptive product gains a foothold in new or low-end markets, the improvement cycle begins. And because the pace of technological progress outstrips customers’ abilities to use it, the previously not-good-enough technology eventually improves enough to intersect with the needs of more demanding customers. When that happens, the disruptors are on a path that will ultimately crush the incumbents.

This is the exact paragraph that underlines the (mercifully-fading) Apple is doomed narrative, and it’s the same paragraph that led so many – again, including myself – to assume that consoles are on their last legs. (And, to be clear, Christensen states that incumbent extinction is the end-game for both “new or low-end” disruptions).

My contention both in the case of Apple and in consoles is that incumbents who are primarily differentiated on the experience of the product, in markets where the buyer is the user, are not in fact doomed. Growth may be limited – as I have consistently said is the case for both Apple and for consoles – but there will always be a market willing to pay for the superior experience delivered by an integrated offering.

The long-term theoretical danger for both Apple and consoles is that some other aspect of the experience outside of their control abandons the smaller high-end market for the booming new (or low-end) market. In the case of both, the danger is losing publishers/developers. That, though, is why I concluded my piece by pointing out that there is still a lot more money in consoles, just as there is in iOS. True, that may change, but it hasn’t yet; when and if it does, I think I’ve demonstrated I’m both capable and willing to change my position.

The full list of topics covered this week in the Daily Update include:

  • The New Structure of Mobile Gaming
  • The Hidden Cost of Microsoft’s Devices
  • Amazon Affiliate Links in the Washington Post
  • Twitter is Great for Unprofitable News
  • Microsoft’s Chromebook Response
  • Google to Offer Account to Children
  • Print, Chinese Walls, and “Objective” Journalism
  • Twitter’s New Photo-removal Policies
  • Steve Ballmer Leaves Microsoft’s Board
  • What Consoles Say About iPads
  • Uber Opens API
  • The Samsung Nook
  • Gaming and New Market Disruption
  • Why the PS4 is Winning
  • Uber Testing On-Demand Product Deliveries

To read all of these updates and to receive future updates, please visit the membership page and sign up!

I’d like to thank all of Stratechery’s subscribers for their support, and for making this site possible.

Podcast: Exponent Episode 014 – The Rise of the Algorithm

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On the newest episode of Exponent, the podcast I co-host with James Allworth:

In this week’s episode we spend a good bit of time revisiting the native ads discussion, then dive into the different ways that Twitter and Facebook have handled the news this week. From there we discuss Twitter’s timeline changes, the realities of venture capital, and whether or not our entire economic system will survive the automation revolution. Yes, it gets deep quickly!

Links

  • Ben Thompson: Print, Chinese Walls, and “Objective” Journalism – Stratechery (members only)
  • Clay Shirky: Last Call – Medium
  • Jay Rosen: When Quoting Both Sides and Leaving it There is the Riskier Call – PressThink
  • Hamilton Nolan: Time Inc. Rates Writers on How “Beneficial” They Are to Advertisers – Gawker
  • Derek Willis: New Republican Leader Finds New Friends, and Quick Cash – New York Times
  • Marco Arment: I’ll Never Fly Amazon Again – Marco.org
  • Ben Thompson: Twitter is Great for Unprofitable News – Stratechery (members-only)
  • Mathew Ingram: Twitter vs. Facebook as a news source – GigaOm
  • Matt Buchanan: The Twitter of Tomorrow – New Yorker
  • Humans Need Not Apply – YouTube

Listen to the episode here

Podcast Information: Feed | iTunes | SoundCloud | Twitter | Feedback

Games and Good Enough

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Two months ago I wrote How Apple TV Might Disrupt Microsoft and Sony. Then, about a month later, I went and bought a Wii U. And, a month after that, I bought a 3DS. And now I’m writing another article about gaming, and I think I’ve changed my mind.

Still, it’s always dangerous to write about anything based on little more than your personal experience, so I’ve been trying to get up to speed on what is happening with gaming. And it’s actually pretty darn encouraging. Sony has sold 10 million PS4s, while Microsoft has sold at least 5 million Xbox Ones. Nintendo is still hurting, but Mario Kart 8 has moved 2.82 million copies while the 3DS now has 9 titles that have sold more than 1 million units. Meanwhile, in PC land Nvidia beat expectations largely because of continued growth in demand for their GeForce graphics processors. At the same time, mobile game companies like King are struggling, and the iPad, which so many – including myself – presumed would take a big chunk out of consoles, has seen its sales slow dramatically (last quarter it was down nine percent year-over-year).

So why did I buy not one but two new consoles? And what, if anything, might that have to do with these rather impressive results?

Last fall I wrote what is probably still my favorite piece on this site: What Clayton Christensen Got Wrong. In the piece I took the idea of low-end disruption head-on. Basically, the theory states that in an immature market, the integrated solution has the advantage, but as a market matures, modular solutions become “good-enough” and are able to leverage a price advantage – and, over time, a scale advantage – to take over the market.

My fundamental contention was that this theory primarily applied to business markets where the buyer was not the user and prices and feature lists reigned supreme. In consumer markets, on the other hand, where the buyer and user are the same person, there would always be a significant part of the population that prioritized the user experience only an integrated solution can deliver, making the high end a profitable segment despite higher prices. My prime example was, of course, the continued success of the iPhone in the face of good-enough Android (please do read the whole thing).

And yet, when I wrote How Apple TV Might Disrupt Microsoft and Sony, I basically built my entire argument on the idea of low-end disruption. My thesis was that a general purpose Apple TV would offer good enough gaming that would appeal to a significant part of the population, and, over time, peel away even those at the high end. That’s what made my 3DS purchase in particular so interesting.

John Gruber perfectly articulated why the 3DS and any future Nintendo handheld is doomed in More on Nintendo and Handheld Gaming:

What’s different about the post-iPhone world of mobile computing is that the buying decision is no longer about or, it’s about and. Pre-iPhone, someone interested in a handheld game device would choose between Nintendo’s offering or someone else’s. Nintendo did well in that world, selling more than enough devices to succeed. Today, though, someone deciding to buy a dedicated handheld game device is, more likely than not, deciding whether to buy something to carry in addition to the mobile device they already carry everywhere. This is an entirely new scenario for Nintendo, and as I see it, they are on course to head right over a cliff.

It’s actually worse than Gruber likely realized: the 3DS is a pretty atrocious piece of hardware relative to an iPhone. Because of the silly inclusion of 3D, the effective resolution is only 400×240 on the DS’s main screen, and it is absolutely brutal to look at. This is not a situation where post-PC devices are on pace to deliver superior graphics: they are already years ahead.

And yet, screen quality notwithstanding, I have probably put in more gaming hours on the 3DS in the last two weeks than I have in the previous two years on the iPhone. Because here’s the thing: touch sucks for playing games.1 The experience of using a dedicated device with built-in gaming controls and games designed specifically for said device mean a great deal to this user and buyer. It means enough that, especially when I’m traveling, I will gladly carry an additional device.

Again, as I noted at the top, I very much hesitate to read too much into my own personal experience. But I’m beginning to suspect that consoles may be a bit more resilient than many of us in tech may have first believed. And, by extension, I suspect my critique of low-end disruption may have legs: when users are buyers the user experience matters, immensely. And the user experience of a console is, and likely will remain, far ahead of any sort of touch device when it comes to many (but not all) types of games. Moreover, I now suspect that an Apple TV that supports gaming will be less disruptive than I suggested as well; as long as the controller is optional, as I suspect it would be, the immersive experience of a dedicated console will be optional as well.

That’s not to say the gaming business is going to thrive: in this Nintendo is indeed a cautionary tale. It seems increasingly clear that the Wii’s incredible success was the worst thing that could have happened to the company. What made the Wii such a hit was that it dramatically increased the market for consoles: lots of people who would not have normally been interested in a PS3 or Xbox 360-type device couldn’t resist Wii Sports. The problem, though, is that the Wii market, by virtue of not being people who particularly valued the traditional gaming experience, was the exact same market likely to see touch gaming as good enough. Keep in mind the Wii launched at the end of 2006, just weeks before the iPhone. In retrospect it was the last hurrah of the gaming middle ground, of a piece with the iPod, point-and-shoot cameras, and other dedicated but low-end devices.

What has happened in all of those markets – indeed, what is happening to smartphones as well – is a bifurcation between the high and low ends. Cameras is a particularly good example: DSLR sales have remained strong2 even as the point-and-shoot cateogry has all but disappeared, replaced by good enough smartphone cameras. That’s the exact same pattern we’re seeing in gaming: the PS4 (and to a lesser degree, the Xbox One) are doing much better than expected, while the lower-priced and lower-specced Wii U is hurting. Nintendo’s mistake was not realizing that the Wii’s market was devoured by touch devices; they should have built a console that was top-of-the-line.

There is one more fascinating parallel between Android/iOS and touch gaming/console gaming: even though Android has far greater market share, the best apps are generally found on iOS largely because the most money is there. Similarly, while gaming as a whole was worth $93 billion last year, only $13 billion of that was in mobile, and much of that in free-to-play games like Candy Crush Saga that appeal to very different players than traditional gamers. In other words, it’s not at all a given that publishers will abandon consoles simply because the market share of mobile devices is greater.

In short, I believe there are factors more important than just market share, at least when it comes to smartphones. Why not when it comes to games?

  1. Board games on the iPad being the big exception, at least for me ↩

  2. They did start to slip last Christmas ↩