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  • Games and Good Enough

    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 ↩

  • Is BuzzFeed a Tech Company?

    It’s telling that Chris Dixon, in a blog post explaining Andreessen Horowitz’s $50 million investment, goes out of his way to explain that BuzzFeed is not really a media company, but a technological one:

    We see BuzzFeed as a prime example of what we call a “full stack startup”. BuzzFeed is a media company in the same sense that Tesla is a car company, Uber is a taxi company, or Netflix is a streaming movie company. We believe we’re in the “deployment” phase of the internet. The foundation has been laid. Tech is now spreading through every industry and every part of the world. The most interesting tech companies aren’t trying to sell software to other companies. They are trying to reshape industries from top to bottom.

    BuzzFeed has technology at its core. Its 100+ person tech team has created world-class systems for analytics, advertising, and content management. Engineers are 1st class citizens. Everything is built for mobile devices from the outset…BuzzFeed takes the internet and computer science seriously.

    The issue is that, generally speaking, media companies don’t make for good venture capital investments. VC firms like Andreessen Horowitz aren’t looking to fund nicely profitable companies; they are searching for home runs, the one or two investments that make a fund profitable despite lots of failures. This means a focus on companies that can scale. Marc Andreessen told Adam Lashinsky in Fortune:

    We describe it is we invest in Silicon Valley style companies. So we invest in the kind of companies that Silicon Valley seems uniquely good at producing at scale, you know, large numbers over time.

    What makes technology companies – software companies, especially – different from media companies is the distribution of costs. Even before the Internet, for a software company, almost all of the costs were up-front fixed costs: you spent money primarily on salaries to develop a piece of software, and you spent that money well before you knew whether or not said software would sell.

    The payoff, though, was that the software itself had minimal marginal costs: it cost basically nothing to produce one more copy (discs and packaging, basically). Thus, the vast majority of revenue for every single copy sold went straight to the bottom line. Moreover, most software is universal: it can be used anywhere (although localization can add to the fixed costs), and it’s useful for a long period of time. That results in the sort of scale that Andreessen was referring to.

    Media companies, on the other hand, have traditionally differed from technology companies in three ways:

    • Created content had a very short shelf life, which leaves a very small amount of time to recoup the fixed costs that went into its creation
    • Media’s marginal costs (paper, ink, delivery) were higher than the marginal costs for software, at least in relative terms
    • Media was generally limited in its geographic availability

    In this pre-Internet world, media did have an ace-in-the-hole: their significant up-front costs often resulted in geographic monopolies that made them the primary option for advertisers. This made media companies interesting investments for hedge funds, but the limited upside meant they were much less attractive to VCs.

    Fast forward to today, and the Internet has seemingly made the differences between technology and media companies even more stark:

    • Packaging is no longer necessary, reducing the marginal cost of software to zero
    • Multiple new business models have emerged for software, such as attracting massive user bases for free which can then be monetized through advertising or premium services1
    • Media, meanwhile, has lost its local monopoly, and advertisers have fled for platforms that have more scale – there’s that word again – and better targeting

    So why on earth is Andreessen Horowitz investing in a media company? Or is Dixon right – is BuzzFeed really a technological company that can use software to succeed in everything from listicles to hard news to now, their own movie production company? What has changed since Andreessen wrote in his post introducing Andreessen Horowitz:

    We are almost certainly not an appropriate investor for any of the following domains: “clean”, “green”, energy, transportation, life sciences (biotech, drug design, medical devices), nanotech, movie production companies, consumer retail, electric cars, rocket ships, space elevators. We do not have the first clue about any of these fields.

    I suspect what Andreessen and company have come to realize in the five years since that post was written is that because of the Internet media is more like technology than it might first appear, and that what Andreessen Horowitz cares about is not the software but the potential scale.

    • Like software, media has zero marginal cost
    • Multiple new business models have emerged for media, such as attracting massive user bases for free which can then be monetized through advertising or premium services
    • The addressable market for media is the connected population of the world, and content is itself self-selecting when it comes to effective targeting

    These are all points that are overlooked by those in the media kvetching about the death of journalism: everything that is hurting traditional media companies – zero marginal costs, “free” expectations, unlimited competition because of global distribution – are opportunities for new media companies unencumbered by traditional thinking.

    So, for example, as Dixon writes about BuzzFeed:

    Internet native formats like lists, tweets, pins, animated GIFs, etc. are treated as equals to older formats like photos, videos, and long form essays.

    And why shouldn’t they be? The only reason to treat a tweet differently than a pull-quote, or an animated GIF differently than a photo, is if you are worried how they will appear in print. Remove those shackles and you realize there is no difference at all. What Dixon didn’t say, though, is that this sort of liberation also applies to monetization, and that includes native advertisements. I’m quite bullish on native advertising, and I think the ethical concerns are overstated. Specifically:

    • “Native” advertisements are how every medium monetizes free content: newspaper ads are stories and pictures, magazine ads are beautiful imagery, radio ads are jingly voice-overs, TV ads are scripted stories, so on and so forth. Still, it took each of these mediums time to figure it out – they all went through their banner advertisement stage, i.e. ineffectually using an advertising format that worked on the old medium.

      In the case of the Internet, content consumption is primarily about either the timeline – think Facebook, Twitter, or even blogs – or the irresistible atomic unit that spreads on social media. We should expect – and applaud – advertising adapting itself to these formats.

    • Newspapers in particular have been the most conscientious about maintaining a “wall” between the business and editorial sides of the businesses. Newspapers, though, as I noted above, were de facto monopolies. So while it certainly benefited journalists that they need not worry about how the newspaper made money, there was absolutely a political benefit to trumpeting the objectivity and impartiality of the editorial side. Newspapers could declare themselves to be above reproach even as they made money hand over fist.

      The situation is far different on the Internet. Anyone anywhere has access to everything on the web,2 which means there are no monopolies on either the news or on advertising. Quite the contrary, in fact: the Internet is the closest thing in human history to a true marketplace of ideas, and the currency is user attention. Ultimately, well-functioning markets are a much better police of ethical lapses than self-rightous arbiters.3

      Moreover, the truth is that bias lurks in any author, or in any ownership structure, something that is of particular concern when it comes to the consolidation of traditional media. One can absolutely make the case that an organization like BuzzFeed, with clearly labeled native advertising, is a lot more trustworthy than any reporting that may come out of an organization like NBC (which is owned by Comcast). Oh sure, NBC journalists will object to that statement, but how can we every truly know?4

    This is what makes BuzzFeed so interesting: absent legacy, media absolutely benefits from Internet economics as long as you can figure out effective monetization, and it’s possible BuzzFeed has done just that, and, just like their product, they have done so by abandoning that which primarily mattered in the old medium.

    This begs a deeper question, then: what is a technology company? I actually don’t buy the idea that BuzzFeed has some sort of magic algorithm that makes what they do possible, and if that’s the basis on which Andreessen Horowitz is investing, then I have a bridge they may be interested in as well. However, the entire premise of this blog is that product is only one part of what matters: so does channel, distribution, advertising, business model and the addressable market. And that is what makes BuzzFeed a “tech” company: the world is their addressable market, and they make money by scaling for free.

    1. Obviously data centers and the like cost money, but again, those are fixed costs, not marginal one: each additional user is “free” ↩

    2. Absent government intervention, of course ↩

    3. Obviously lots of markets are not well-functioning; I’m not an absolutist here. However, when it comes to what is read online, it is much more of a level playing field than almost anything you can compare it to. That this blog is read at all is testament to that; hopefully, the fact I am monetized by my readers is a competitive advantage ↩

    4. To be fair, the same criticism applies to Andreessen Horowitz’s involvement in BuzzFeed, and this aspect makes me just as uncomfortable as Comcast owning NBC. Moreover, it certainly is convenient that Marc Andreessen sits on the board of Facebook, BuzzFeed’s most important channel ↩

  • How Technology is Changing the World (P&G Edition)

    I’ve been surprised at the amount of attention my little corner of Twitter has given to the news P&G, the largest CPG company in the world, is making significant cuts to its brand portfolio (a Marc Andreessen tweetstorm certainly helped). From the Wall Street Journal:

    Procter & Gamble Co. will shed more than half its brands, a drastic attempt by the world’s largest consumer-products company to become more nimble and speed up its growth.

    The move is a major strategy shift for a company that expanded aggressively for years. It reflects concerns among investors and top management that P&G has become too bloated to navigate an increasingly competitive market.

    Chief Executive A.G. Lafley, who came out of retirement last year for a second stint at the company’s helm, said P&G will narrow its focus to 70 to 80 of its biggest brands and shed as many as 100 others whose performance has been lagging. The brands the Cincinnati-based company will keep—like Pampers diapers and Tide detergent—generate 90% of its $83 billion in annual sales and over 95% of its profit.

    The obvious way to interpret this news is to assume, as the WSJ did, that the reason for this move is to “become more nimble” and that P&G has “become too bloated.” This has certainly been the take of most of the folks in my Twitter feed, who have long been regaled by tales of Apple’s focus in particular:

    I think, though, there is something much deeper at play here, and it’s far more of a tech story than a superficial Apple comparison might suggest.

    One of the more interesting – and telling – factoids about the consumer packaged goods (CPG) market is that there are no product managers; rather, there is a very similar position called a “brand manager.” The nomenclature is no accident: while tech products have traditionally differentiated themselves by their product attributes, the distinguishing feature of your typical consumer product is its branding and positioning.

    Take something like health and grooming products: on a product level there are not massive differences between, say, Axe and Dove. But their branding could not be more different. Dove has had massive success with their “Real Beauty” campaign that fights against highly sexualized stereotypes that only serve to make most women feel worse about themselves:

    An ad from Dove's 'Real Women' campaign
    An ad from Dove’s ‘Real Women’ campaign

    Axe, on the hand, in an attempt to appeal to young men, heavily emphasizes exactly the sort of stereotypes Dove is objecting to:

    Not exactly a 'real' woman
    Not exactly a ‘real’ woman

    Here’s the kicker, though: Axe and Dove are both owned by Unilever, the Anglo-Dutch CPG conglomerate.

    When we in tech talk about identity, we’re usually talking about the ability to manage individuals, whether that be for connecting to corporate networks or for effectively running ad networks. In social science, however, the concept of identity is about a person’s own personal conception of who one is and one’s place in the world.1 It is this definition of identity that is at the root of effective branding. What both Dove and Axe are doing in the above ads is appealing to identity: to use Dove products is to reject society’s expectations and to embrace your identity as a woman; to use Axe is to drown insecurity and affirm your manliness, whatever that means.

    In fact, if you squint, you can see that both Dove and Axe are trying to accomplish basically the same thing but for two totally different audiences; while the ends may be similar, the means are necessarily different. Moreover, identity is not just about demographics: it is also about psychographics – things like personality, opinions, lifestyles, etc. This means that, by definition, one brand can not fit all. That is why Unilever sells both Dove and Axe, and it’s the primary reason why P&G has nearly 200 brands of its own: when you can’t differ hugely on product2, you find growth through winning niche by ever-more-specialized niche.

    There is one more factor that explains P&G’s brand proliferation: shelf space. The most effective way to beat out competition is to have your product in front of the customer – and to ensure your competitors’ are no where to be found. Buying decisions for low cost/relatively undifferentiated items are not made through extensive research and online price comparisons; rather, you need body wash, so you go to the body wash aisle, and pick from what is available. P&G leveraged its size and ownership of dominant must-stock brands like Tide, Pampers and Gillette to finagle the maximum amount of shelf space possible, and then filled that shelf space with a cornucopia of specialized brands that not only appealed to specific niches, but also kept competitors away from P&Gs real breadwinners.

    So how, then, have changes in technology forced P&G into a different direction?

    The first change has been the massive increase in noise. It is so much more difficult today for a brand to break through, especially as compared to the halcyon days of one local newspaper and three broadcast channels. Today there are not only TV channels galore, but display advertising, search advertising, Facebook, Twitter, and more. While it is true that uber-specialized brands can now more easily hone in one specific niches, that takes real money and is much more difficult to pull off across 200 brands. P&G has likely realized that many of its brands were simply getting drowned out, rendering the money spent marketing them effectively worthless. Thus P&G has decided it needs to “go big or go home” – either spend a lot of money to make sure a brand stands out, or simply get rid of the brand.

    This is a phenomenon that is playing out across multiple industries. For example, it is significantly easier today to get a startup off the ground; however, that actually means startups need more venture capital, not less, because the real challenge is marketing and/or sales (and thus, by extension, venture capital is bifurcating between very large and very small). The same thing is playing out in the app store. Similarly, there are a few big winners when it comes to journalism and attention, with many medium-sized players fighting for survival. In music stars like Beyoncé are richer and more powerful than ever before, while many smaller acts are struggling to survive. The ease with which information flows means we all get a whole lot more of it, which actually makes it more likely we glom onto whatever it is that stands out, which makes it stand out even more.

    The other big technological change that is affecting P&G’s strategy is e-commerce. As I’ve previously noted in the context of Amazon:

    Jeff Bezos’ critical insight when he founded Amazon was that the Internet allowed a retailer to have both (effectively) infinite selection AND lower prices (because you didn’t need to maintain a limited-in-size-yet-expensive-due-to-location retail space).

    That’s great for Amazon, but not so great for P&G: remember, dominating shelf space was a core part of their strategy, and while I’m no mathematician, I’m pretty sure dominating an infinite resource is a losing proposition. What matters now is dominating search. That is the primary way people arrive at product pages like this:

    Most customers arrive at this page via search, not browsing
    Most customers arrive at this page via search, not browsing

    There are two big challenges when it comes to winning search:

    • Because search is initiated by the customer, you want that customer to not just recognize your brand (which is all that is necessary in a physical store), but to recall your brand (and enter it in the search box). This is a much stiffer challenge and makes the amount of time and money you need to spend on a brand that much greater
    • If prospective customers do not search for your brand name but instead search for a generic term like “laundry detergent” then you need to be at the top of the search results. And, the best way to be at the top is to be the best-seller. In other words, having lots of products in the same space can work against you because you are diluting your own sales and thus hurting your search results

    The way to deal with both challenges is the same way you break through the noise: you put more focus on fewer brands.

    There is a lot that tech companies can learn from companies like P&G. Probably the biggest one is that brand matters. It is the key to breaking through the noise and a major part of sustainable differentiation. However, it’s also worth noting that even after this cull P&G is still going to have nearly 100 brands: that’s because identifying and serving specific groups matters as well. P&G is trying to figure out the balance between specialization and reach that makes sense for them as a Fortune 50 company, and right now that balance is leaning towards less specialization and more reach.

    However, I think that means the opposite is the case for smaller players: the Internet may be noisy, but it also makes it possible to identify and reach niches that were previously too hard to segment or reach at a scale great enough to support a business. As I wrote last week, independent app developers ought to pursue a niche strategy, but so should writers, musicians, and even CPG startups.

    More broadly, I strongly believe P&G’s changes are yet another example of how technology is touching – and massively changing – every single industry. To be sure, P&G has been at the forefront of using technology in its business practices, but now technology is changing the very foundation of how they approach business itself. And, in a way, it speaks to how impressive P&G is as a company that they are among the first to significantly alter their business in the face of these changes; they won’t be the last.

    1. It really is fascinating how “identity” as used in tech is the total inverse of “identity” as used in social science. The former effectively reduces people to a row in a database; the latter is about expressing uniqueness ↩

    2. Although, to be clear, P&G spends a lot of money and effort on R&D ↩

  • Pleco: Building a Business, not an App

    This past week has not been the first outbreak of independent developer angst over the app store, but it feels like it has been one of the more intense. The pump was primed by the news that Kim Kardashian: Hollywood is on pace to make $200 million this year, news that was in stark contrast to Brent Simmons’ observation that there didn’t seem to be many indie iOS developers (I think his is the post that kicked the discussion off; Simmons’ blog contains a good roundup of all the posts that ensued).

    The high point though — or low point, I suppose — was when Jared Sinclair revealed the sales numbers for his excellent iOS RSS reader Unread:

    Unread for iPhone has earned a total of $32K in App Store sales. Unread for iPad has earned $10K. After subtracting 40 percent in self-employment taxes and $350/month for health care premiums (times 12 months), the actual take-home pay from the combined sales of both apps is $21,000, or $1,750/month.

    Considering the enormous amount of effort I have put into these apps over the past year, that’s a depressing figure. I try not to think about the salary I could earn if I worked for another company, with my skills and qualifications. It’s also a solid piece of evidence that shows that paid-up-front app sales are not a sustainable way to make money on the App Store.

    First off, Unread is a great app that I myself use, and Sinclair is a very interesting and provocative blogger who has written some really strong pieces about design and iOS 7 in particular. I’ve also had the pleasure of meeting him in person and consider him a friend, and admire his willingness to share his financials even if they aren’t as great as he might have hoped.

    That said.

    Sinclair’s results are not a “solid piece of evidence” of anything. They are an anecdote. And as long as we’re drawing grand conclusions from single data points, I thought it might be useful to look at someone on the other side of the spectrum. So I called up another friend of mine, Mike Love.

    pleco-phone

    Love makes Pleco, the preeminent Chinese dictionary on the app store (iOS, Android). Pleco is not by any means a new app; in fact, it was first developed for the Palm (I actually bought a Palm in 2003 for the express purpose of using Pleco). Here’s Love on its genesis:

    I was an exchange student in China and launched the app on Palm in 2001. The signature feature was handwriting recognition (licensed from Motorola) which nobody else had at that point. The problem [for other Chinese dictionaries] was that Palm didn’t have a Chinese font built-in, it did not in fact have Unicode support [or other Chinese text encodings]…you could only get Chinese working on it all through a hack. So having it all in one place, no extra setup needed, no buying licenses to three different $30 apps to get it working, that was kind of the key part of it.

    The one other thing we had besides the handwriting and Chinese support was that we exclusively licensed the Pocket Oxford Chinese dictionary…[everyone else used] CEDICT which had been less exhaustively edited and had no parts of speech or example sentence.

    What stands out to me about Love’s approach was that from day one his differentiation was not based on design, ease-of-use, or some other attribute we usually glorify in developers. Rather, he focused on decidedly less sexy things like licensing. Sure, licensing is particularly pertinent to a dictionary app, but the broader point is that Love’s sustainable differentiation was not about his own code. Sustainable differentiation never is.

    I decided to do the iOS app pretty much as soon as Apple announced the app store…but I was in the middle of a pretty ambitious update for Palm and Windows Mobile, so we were pretty late and there were a bunch of other dictionaries on iOS [by December 2009, when Pleco for iOS launched].

    Love noted that although Pleco was quite late – there were multiple Chinese dictionary apps in the store – they were fortunate that Apple had just started allowing free apps to offer in-app purchases. So, even though Pleco had always been a paid download on Palm, Love immediately took advantage of the new business model:

    Our initial plan in iOS had been to have some sort of free lite app, some sort of slightly nicer paid app with a minimum set of features, and then you could buy other stuff as add-ons. Then in October 2009 Apple announced they were lifting the ban on free apps having in-app purchase so immediately we retooled the whole thing to be free with in-app purchases.

    Love thinks the fact he started from day one with the new business model in mind gave him a competitive advantage to the dictionaries already in the store, but I think he sells himself short; after all, it’s been five years and only now are most independent developers starting to realize that free with in-app purchase is the only viable monetization model. To put it another way, Love differentiated himself again by being a student not just of APIs and frameworks, but of business models as well. More from Love:

    Unlike others, our free app had not only CC-CEDICT (the evolution of the aforementioned CEDICT), we actually licensed another Chinese-English dictionary which we called the PLC dictionary and offered that in our free app and we thought it would be a nice differentiator compared to all of the CC-CEDICT apps because it had sample sentences and other nice things that they didn’t have.

    This point blew me away. Love invested real money into differentiating his free app (Love still had the great handwriting engine, but iOS’s built-in handwriting – while hugely inferior – had lessened that advantage). Love was confident that after he won in free, he could make up the difference with his plethora of paid add-ons, which at this point included not only additional dictionaries – several of them exclusives – but also modules like stroke order diagrams, different fonts, a document reader, and a year later, optical character recognition (OCR).

    At this point I asked him about price. One thing to note about developing on Palm was that significantly higher prices were the norm. Pleco on Palm was available in three different bundles, depending on your choice of dictionary, for prices ranging from $60 to $120. Surely that wasn’t possible on iOS, or was it?

    We launched with a basic bundle for $50, a professional bundle for $100, and a complete bundle for $150. So pretty close to the Palm prices actually.

    But surely prices have fallen, right?

    We actually charge mainly the same prices. Our lowest bundle is $40, but it doesn’t include an additional dictionary now, just features. Some people didn’t like the dictionary we were offering in the basic bundle so we felt it would be more flexible to have a cheaper bundle that didn’t have any dictionaries with the assumption that people could buy whatever dictionary they wanted to go with it. The pricing change helped though – we’re actually netting more off of the basic bundle now than we were when it was $50. The cost reduction actually did us some good.

    Pleco's bundles. Individual features and dictionaries are also sold separately.
    Pleco’s bundles. Individual features and dictionaries are also sold separately.

    Love’s high prices have not hurt sales:

    • Pleco has about 100 times the number of customers as Pleco on Palm/Windows Mobile (thanks to being free)
    • Those free customers convert at about a 5% clip, meaning Love has about 5x more paying customers than he did previously (Palm/Windows Mobile did not have a free edition)
    • Net revenue per customer has been cut by a third, primarily due to significantly higher royalty rates charged by publishers who realized Pleco was cutting into their book sales

    Pleco also has an Android version that makes about a third as much revenue as the iOS version, although Love noted it takes up a lot more than a third of his time. I asked him if it was worth it:

    As a brand expansion, yes. The number of sales we get from the fact that when a typical student starts their Chinese class or exchange program and you get a little sheet, and the sheet says “Here’s some useful Chinese things you should get” and Pleco is one of them, that’s very valuable, and making sure that Pleco is the only app on there and you don’t need to recommend some other app for Android, that’s valuable.

    I think this is a crucial point: Love owns his niche, and he is willing to do whatever is necessary to ensure that remains the case.

    In a follow-up post to the one quoted above Sinclair wrote:

    Arguments that I naively built and marketed an RSS reader in 2014 aren’t relevant to the heart of my article. Any polished app — in any category, with any amount of marketing or promotion — is a lottery. Increasing the marketing budget is just as likely to increase the potential losses as it is to increase potential sales. Each niche is an apple or an orange. It’s all a gamble.1

    Love is testament this is absolutely not true. He has identified a niche – Chinese language learning – and over many years he has worked diligently to be the app for that category. Much of that time has not been spent on development or design. Rather, it’s been spent understanding and listening to customers (which led to the aforementioned bundle change), making business deals with slow-moving publishers, careful consideration around pricing and app store presentation, investments in both free and paid differentiators, and a whole bunch of time spent on an Android app that doesn’t make that much direct money but that marks him as a leader in his space.

    Make no mistake, Love has had his breaks, particularly his having started with favorable licensing terms, but I would ask every indie developer who is bemoaning his or her fate in the app store:

    • Are you serving a niche that has a clear need, an audience that is willing to pay, and that is large enough to sustain your app?
    • Have you developed sustainable differentiation that is more tangible than just look-and-feel?
    • Do you have a fully thought-out monetization model that lets you make a meaningful amount from every customer you serve? If your app is truly differentiated then you need to charge customers accordingly
    • Have you invested just as much if not more effort in non-development functions like making partnerships, licensing, promotion, etc.?
    • Have you made an Android app?

    All of this is table stakes for any developer, indie or not, and as much as I like Sinclair personally, the lessons I draw from his experience is not that the app store is broken, but rather that he built a bad business (particularly in his choice of market). If doing everything I listed doesn’t sound attractive, or realistic, if all you want to do is develop and make something beautiful, then you need to get a job that will pay you to do that. To be an indie is to first and foremost be a businessperson, and what I admire about Love is that he is exactly that. His development skills are a mean, not an end.

    To be clear, Apple could do much more to make things easier for developers of all sizes. Two in particularly would make a big difference:

    • Trials: One of the big advantages Love has in his space is that it is possible for him to offer a highly useful (and differentiated) free app along with a whole slew of paid add-ons. There are other categories, though, where to remove features would render the app useless. These sorts of apps need app-store supported time-limited trials along the lines of the Windows Store:
      The Windows Store lets developers set up time-limited trials of up to 30 days with the click of a button.
      The Windows Store lets developers set up time-limited trials of up to 30 days with the click of a button.

      This would quickly make clear which apps in a given niche were the best, because customers could try them all, and that developer could charge accordingly. Over the long run, different niches would end up with different apps at different prices, with price as a signifier of quality (which, of course, the customer could verify through a trial)

    • Paid Upgrades: The key to any sustainable business, whether it be a restaurant, airline, or app developer, is to make money off of your best customers over time. Apps with a service component, like Evernote, or ones with an ever-increasing array of in-app purchases, like Pleco, do this successfully. Again, though, there are other types of apps that are complete experiences unto themselves. Right now there is little motivation for a developer to invest time in improving their app, because the people who are mostly likely to appreciate those improvements – the current customers – can’t pay. It is true you can release a separate app entirely, but then you lose access to the original app’s data, plus you have no means of communicating with your current customers to let them know why they should update.

    Apple really should care: the iOS ecosystem is one of the iPhone’s biggest differentiators, and absolutely one of the reasons Apple maintains its impressive margins. But independent developers also need to appreciate that the iOS app store, with its minimal barriers to entry and massive consumer audience, requires that they first and foremost be businesspeople.

    Love reminisces:

    I do miss the Palm days. The thing about that is it was much more about writing apps for people like me. I think a lot of people complaining about the state of the app store now are realizing it doesn’t work that way anymore – but in the early days of the iOS app store it did. People on Palm just wanted you to add cool stuff. They wanted more features, they were excited by the same things I was excited by.

    This is the critical point: developers all want to write an app for themselves, which means everyone has. That’s why there is no money to be made in something like an RSS reader. But there are whole swathes of people out there who have really interesting and specific needs – like Chinese language learning – just waiting for someone who can not only develop, but can also do market research, build a business model, and do all the messy stuff upon which true differentiation – and sustainable businesses – are built.2

    1. In a follow-up conversation, Sinclair expounded on this, saying, “The scale of the App Store might lead a newcomer to believe that even a small niche is capable of generating satisfying revenues for a solo developer.” To me this seems to be saying the same thing, but judge for yourself ↩

    2. Note: For this article I also interviewed Elia Freedman, another former Palm developer who has built the best financial calculator on the app store (no, really – look at the reviews). My thanks to him for this time, and definitely check out both his apps (he has a whole suite of calculators), as well as his very thoughtful blog (where he disagrees with me about trials)  ↩

  • Losing My Amazon Religion

    Benedict Evans asks a good question:

    The growth curve is impressive enough, even before you notice that the scale is logarithmic. And to be sure, Amazon has had doubters from the beginning: few gave the company a chance when it started, and even fewer thought it would survive the bursting of the bubble. And yet, today Amazon is the king of e-commerce, at least in the United States, and the clear leader in cloud services, and now they are making a big push into digital content and devices.

    I too was once a skeptic. I remember several years ago, after being invited for final interviews with Amazon, I decided that I wouldn’t take the job even if offered.1 Beyond the fact the retail-focused role wasn’t a great fit, I was also concerned that total compensation at Amazon, at least relative to other established tech companies, is heavily stock-based. At that time the stock was trading at a price-to-earnings ratio of nearly 90, which on the surface seemed unsustainable, and it didn’t seem worth the risk.

    As of today, the stock price has doubled.

    Since that time I’ve come to appreciate what an incredible business Amazon has built, as well as the size of the opportunity. Just about a year ago, when every one was freaking out about Amazon’s earnings (this week’s angst is nothing new), I wrote about Amazon’s Dominant Strategy:

    Jeff Bezos’ critical insight when he founded Amazon was that the Internet allowed a retailer to have both (effectively) infinite selection AND lower prices (because you didn’t need to maintain a limited-in-size-yet-expensive-due-to-location retail space). In other words, Amazon was founded on the premise of there being a dominant strategy: better selection AND better prices – the exact same as Sears.

    And, just like Sears, Amazon has added convenience. No, they haven’t opened retail stores; instead they created the amazing Amazon Prime.

    In a happy coincidence, the same day I posted my piece the aforementioned Benedict Evans posted his own defense of Amazon:

    Amazon is constantly creating new business lines. When they start, like any new business, they’re loss making. But they don’t ‘flip a switch’ to get to profitability – they just grow and execute, like any other business…

    To put this another way, Amazon is LOTS of different startup ecommerce businesses on one platform. All the profits from the ones that work are spent on new, loss-making ones.

    This approach makes sense of the compensation scheme I was nervous about: small autonomous teams have a lot of agency over their own results, even as they all work for a mutually shared outcome, and each team has a part to play. Older groups like books and media are the cash cows, funneling profits to growth engines like clothing or shoes or auto or any of the myriad of businesses under Amazon’s roof, all of them focused on the massive e-commerce opportunity (e-commerce is still only 6% of United States’ retail), and each doing their part to deepen the moat that is Amazon’s scale, logistics network, and multi-sided marketplace of customers, suppliers, and third-party merchants.

    My confidence had been further bolstered by the approach Amazon had taken with Kindle: while their own devices had created the market, Amazon was quick to have a Kindle app immediately available on all platforms. Clearly they understood that e-commerce – and its digital equivalents – was a service business that needed to be in front of as many people as possible; to be overly focused on their own devices would be a mistake.

    I could even see the point of the Kindle Fire tablet; at that point the cheapest iPad was $500, and Android-based tablets were even more expensive. Here came an alternative for half the price, and even in version one the seamless integration of media you owned, were subscribed to, or could purchase was brilliant. Amazon’s investments into digital media were understandable: their e-commerce business was originally built on books, CDs, and DVDs, but all of those were going away in favor of digital alternatives. Worryingly, Amazon was barred from selling said alternatives on iOS devices, so it made sense to offer an iOS alternative with their media stores fully integrated.

    It’s on this point, though, that the Amazon narrative starts to break down, at least for me. See, while Amazon’s revenues keep going upwards, their costs do as well – as, indeed, they always have. Those costs, though, are increasingly not about e-commerce, but rather two areas in particular: devices and video.

    Amazon’s financials are famously opaque, and the investments the company is making in streaming video rights, original programming, and their devices are spread around between Cost of Sales, Fulfillment, and Technology and Content. Complicating matters is that spending for Amazon Web Services falls in the latter bucket as well. Still, in 2013 BTIG estimated that Amazon would spend $500 million that year on video, and FierceOnlineVideo has put this year’s expenditures at nearly $1 billion. Last quarter’s 10-Q noted (emphasis mine):

    The increase in cost of sales in absolute dollars in Q2 2014 and for the six months ended June 30, 2014, compared to the comparable prior year periods, is primarily due to increased product, digital media content, and shipping costs resulting from increased sales, as well as from expansion of digital offerings.

    And, in the earnings call, Amazon’s CFO said spending on original content in particular would keep going up:

    So video content, for example, we’re ramping up the spend from Q2 to Q3 significantly. And so it’ll be also a significant growth year-over-year. Keep in mind we have two types of content. We have licensed content. We also have original content. A lot of you have probably seen a lot of the announcements that we’ve green-lighted a number of pilots. We’re going to be in heavy production in those series that have been green-lit during Q3. We’ve also announced a number of pilots that will be in production on. And so that original content, it’s a portion of our total content, will be over $100 million in Q3.

    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?

    Best I can tell, Amazon’s story goes something like this:

    • Amazon gets or creates exclusive content at considerable cost
    • Customers are attracted to said exclusive content and thus sign up for Amazon Prime
    • Because customers are members of Amazon Prime, they start spending significantly more on e-commerce

    Oh, and since mean ol’ Apple won’t allow Amazon’s digital content to be sold on iOS, Amazon will make devices to better sell said digital content. Which will ultimately accrue to e-commerce. And, profit!

    I suppose this makes a certain kind of sense, but it reeks of what a former manager of mine calls a “double bank shot.” Amazon seems to be arguing that through this rather convoluted chain of events, all of which carry significant challenges and risks that are outside Amazon’s expertise (content creation, ecosystem development, etc.), they will be better placed to increase e-commerce’s share of retail.

    Here’s my question: why not spend all that money – and time and executive attention – on simply growing e-commerce? Instead of pushing for the Prime Rube Goldberg machine, how about simply advertising Prime? And instead of pursuing a separate ecosystem, with all of the challenges and incentive risk that implies, why not focus on both building better apps and on creating partnerships with Apple in particular (who certainly has no intention of competing in e-commerce; Google is obviously much more of a competitor)?2

    Moreover, I’m concerned about the internal incentives that Amazon is creating for itself. Amazon is increasingly competing with its suppliers, particularly in the digital space, and I just noted that potential partners like Apple are instead rivals. More concerning is the effect of devices on the company’s overall strategy. In the Fire phone introduction, Bezos was very clear that any device needed differentiation. His answer was Dynamic Perspective, but when that doesn’t work – spoiler: it doesn’t – the easy fallback is to differentiate on services. This will be particularly tempting given that Amazon is clearly looking to make a profit on each device sale. I can’t overstate what a terrible idea this is; I hate the Fire phone not because it seems to be a terrible product, but rather because I see its very existence, at least in the current incarnation, as actively harmful to Amazon’s core business, which needs to be great on all devices.

    So what exactly is going on? Why is Amazon building vertical devices that don’t fit a horizontal company? Why are they pursuing convoluted double-bank-shot strategies that are extremely expensive and high risk? All of these are much more pressing questions than why Amazon is or isn’t making a paper profit.

    • The first possible explanation is that Amazon’s core e-commerce business is in fact very threatened by the shift to mobile, and they feel they have no choice but to build their own platform with its own lock-in.

      The biggest problem with mobile is that, according to Michael Mace, while PC shoppers convert at about a 3% rate, mobile shoppers are a mere 1%. That’s a massive drop-off. Moreover, the rise of apps as a primary channel makes vertical and brand-specific retailers just as accessible and visible as Amazon (in contrast, few people go directly to specific web sites).

      In addition, the sort of shopping experience that Amazon is particularly strong in – extensive research, reviews, etc. – simply doesn’t work as well on mobile. What does work well are things like flash sales or direct marketing pitches. These new marketing and conversion channels threaten to break into Amazon’s share of wallet: you may not necessarily have bought an item purchased in a flash sale from Amazon, but you do have that much less to spend for the rest of the month.

    • At the other extreme, it’s possible that Bezos simply wants to rule the world, at least when it comes to buying and selling anything that can be bought or sold. It’s certainly hard to doubt the guy!

      Still, the Fire phone in particular gives me pause. Beyond the incentive issues I noted above, rumor has it that Bezos was very involved in the Fire phone’s development process, and that he fashions himself as a product guy. The way-too-long introductory keynote certainly hinted at a certain grandiosity about the phone and its development process.

      The problem, though, is that the phone is simply not good. Bezos is clearly an operational and organizational genius, but there is nothing in Amazon’s history to suggest he is a product person.3

    These are two rather unappealing possibilities from an investor perspective: a rational response to a mortal threat, or an irrational belief Amazon can seize a seemingly non-existent opportunity. And still the question remains: what’s wrong with simply focusing on the massive e-commerce opportunity? Again, I don’t mind that Amazon doesn’t make profits; I love the way they are constantly building new businesses from scratch. But why can’t those new businesses leverage Amazon’s strengths instead of accentuating its weaknesses?

    Or, perhaps there remains truths I still do not fully understand. I was wrong about Amazon in 2010, but my error was one of depth; once I took the time to understand the company, I became a believer. This time though, feels different: I want to give the benefit of the doubt, but I don’t believe in double bank shots or blind faith.

    (Check back in 2018 when I write about how I was wrong).

    Update May 2015: I was wrong, and it only took me a year: see The AWS IPO

    1. I try to make decisions before I have to ↩

    2. To be clear, this ship has long since sailed; I’m referring to what Amazon could have done instead ↩

    3. An earlier version suggested that no one at the company was a product person; that is obviously not true and was unfair. What I meant to say is that Amazon’s specialty is not finished physical products; rather, they are a services company that improves iteratively. There is nothing wrong with this (it’s something that Apple, for example, is terrible at)  ↩

  • Big Blue and Apple’s Soul

    I hope you’ll forgive my writing about week-old news,1 but I find it striking to compare the paucity of words written about Apple’s partnership with IBM, at least relative to what was written when Apple acquired Beats. After all, the IBM partnership is a much bigger deal.

    It certainly seems that Tim Cook feels the same. On yesterday’s earnings call Cook spent, by my count, five times the amount of time talking about IBM than he did Beats2, much of it unprompted by questions. The key paragraph was this one:

    We also are in the — virtually all Fortune 500 companies, we are in 99% of them to be exact and 93% of the Global 500…[but] the penetration in business is low. It’s only 20%. And to put that in some kind of context, if you looked at penetration of notebooks in business, it would be over 60%. And so we think that there is a substantial upside in business. And this was one of the thinkings behind the partnership with IBM that we announced last week. We think that the core thing that unleashes this is a better go to market, which IBM clearly brings to the table

    In other words, lots of enterprises have dabbled with iOS, but Apple doesn’t have an effective way to sell more.

    Apple is in a fascinating position when it comes to the enterprise: it turns out that iOS is the best choice for enterprise from a product perspective.3 Blackberry has the integration, but everything else is obsolete; Android has less-effective device management built in and suffers from the usual Android fragmentation issues (which are improving),4 while Windows Phone, shockingly, has only in the last update added basics such as VPN support.5

    However, especially in the enterprise, product is not enough; in fact, very few devices are sold to enterprises as-is. Rather, they are delivered as part of “solutions”, the total cost of which is multiples greater than the underlying device. These “solutions” include things like custom software, implementation, training, consulting, and service contracts. Each of these pieces is fully customizable and negotiable for each enterprise customer, and it is for this you need a massive sales force. Ultimately, no matter how good of a product the iPhone may be, without the sales force and willingness to build “solutions” – the right go-to-market, in Cook’s words – Apple was never going to fully realize the enterprise opportunity.

    The problem is that building said sales force is massively expensive, and not just in dollars: it has a big impact on a company’s culture.6 As Jobs wrote in his biography:

    The company starts valuing the great salesmen, because they’re the ones who can move the needle on revenues, not the product engineers and designers. So the salespeople end up running the company. John Akers at IBM was a smart, eloquent, fantastic salesperson, but he didn’t know anything about product. The same thing happened at Xerox. When the sales guys run the company, the product guys don’t matter as much, and a lot of them just turn off. It happened at Apple when Sculley came in, which was my fault, and it happened when [Steve] Ballmer took over at Microsoft. Apple was lucky and it rebounded, but I don’t think anything will change at Microsoft as long as Ballmer is running it.

    To Jobs this was anathema. If Jobs was adamant about anything it was that Apple always focus on creating the best possible product. If that meant forgoing a massively lucrative enterprise market, then so be it.

    That, though, is what makes this partnership so brilliant for Apple. By offloading everything onto IBM – who is playing the role of what’s called a “Value-added reseller” (VAR) – Apple can now sell into the enterprise without building the sales capability that in the long run would be poisonous to the product-centric mindset that is their ultimate differentiator.

    To be clear, while I’ve been writing from Apple’s perspective, this is an even bigger deal for IBM. As I just noted, the total cost of a VAR “solution” is usually multiples greater than the cost of the underlying device or software; fully integrating a device into an enterprise is a messy business, but dealing with messiness is not only worth a lot of money, it also entails building deep and ongoing relationships with the company you are servicing. In other words, when it comes to the sort of enterprise deals that IBM is going to put together, iOS devices are much closer to commodities; it is IBM that will provide the most value from the enterprise’s perspective. This is a risk for Apple: it’s certainly possible to envision a scenario where IBM switches out iOS for another platform, and there will be nothing Apple can really do about that.

    I’m sure, though, that Apple is well aware of this and counts it as a price they are willing to pay7 (in addition to the commission they’ll likely pay IBM on each iPhone or iPad, in case it’s not clear who will be the lead in this partnership). Apple is getting access to a massive market that had long been off-limits, and they are doing so without giving up their product-centric soul.

    1. I was on vacation at the time ↩

    2. 777 words versus 174 ↩

    3. It’s hard to overstate what a change this is; Apple has always prioritized the user experience over features, but in a market where the buyer is not the user, a user experience advantage is worthless. That’s what Steve Jobs was driving at in this classic clip ↩

    4. Note: I originally said Android lacked device management completely, which was not right. I apologize for the error ↩

    5. There is no greater example of Microsoft’s misplaced hubris than in launching Windows Phone without any enterprise features in the belief they could knock the iPhone off in the consumer market. Remember this? ↩

    6. To be clear, I have no problem with sales forces or their effect on culture – they are critical for enterprise businesses. The issue is when you try to do both enterprise and consumer ↩

    7. This is also an interesting contrast to Apple and Google Maps; in this case, Apple is prioritizing their culture over control. When it came to maps Apple prioritized control over the product ↩

  • It’s Time to Split Up Microsoft

    To understand why so many serious Microsoft observers were encouraged by Satya Nadella’s week-ago memo Bold Ambition and Our Core,1 it’s useful to go back 10 years and read Steve Ballmer’s 2004 memo Our Path Forward. It was around this time that cracks were first starting to appear in the Microsoft machine: the stock had been stagnant for going on four years, Windows XP was besieged by a security crisis, and Microsoft was about to announce the reboot of Windows Vista née Longhorn. Meanwhile, the iPod was exploding, and Google’s stock price had quadrupled since its IPO earlier that year on the back of its 85% share of search.

    In response, Ballmer said that Microsoft needed to innovate:

    The key to our growth is innovation. Microsoft was built on innovation, has thrived on innovation, and its future depends on innovation. We are filing for over 2,000 patents a year for new technologies, and we see that number increasing. We lead in innovation in most areas where we compete, and where we do lag – like search and online music distribution – rest assured that the race to innovate has just begun and we will pull ahead. Our innovation pipeline is strong, and these innovations will lead to revenue growth from market expansion, share growth, new scenarios, value-add through services (alone and in partnership with network operators), and using software to open up new areas. Our focus areas are:

    Ballmer then listed 10 different areas of “focus”, the vast majority of which were themselves so broad as to be meaningless. More disturbing than Ballmer’s abuse of the word focus, though was the fact that mobile barely figured in those ten areas. Here is the one mention:

    Non-PC Consumer Electronics: The opportunity is virtually unlimited to integrate the richness and intelligence of the PC world with everyday devices such as mobile phones, handheld devices, home entertainment and TV. At the center of our efforts are products such as Pocket PC and Smartphone, Portable Media Center, MSTV, MSN TV, Windows Automotive, the Windows Media Center Extender, and other electronic devices built on Windows CE and Windows XP Embedded.

    Even here, mobile phones are only useful insomuch as they “integrate the richness and intelligence of the PC world.” Ballmer and Microsoft simply could not break free of their Windows-first mindset, and while it would be another 3 years before the iPhone arrived, it was this memo and what it represented that marked the beginning of Microsoft’s decline.

    The Power of Monopoly

    It’s easy to dump on Microsoft now, but even easier to forget just how impressive and seemingly impregnable their core business once was.2 I have written multiple times that tech companies ought to be either vertically/platform focused, with software and services that differentiate hardware (like Apple), or horizontally/service focused, with the goal of offering superior software and services on all devices (like Google and Facebook). To try and do both, as Ballmer explicitly did with his “Devices and Services” strategy, is to do neither well: differentiating your devices by definition means offering an inferior service on other platforms; offering superior services everywhere means commoditizing your own devices. “Devices and Services” was nonsense.

    Still, it’s understandable why Ballmer thought differently: Microsoft in the 90s managed to do exactly what I just said was impossible. Because Windows was a monopoly, making their software and services work everywhere meant making them work on Windows. There was no choice between horizontal and vertical, and the company profited fabulously. Over time Microsoft added a server component to this virtuous cycle: people depended on Office, which ran on Windows, and was enhanced by services like Exchange Server, Sharepoint Server, SQL Server, etc. It didn’t matter that Office for Mac kind of stunk; that product mostly existed because of a (failed) attempt to fend off antitrust watchdogs, and it made a ton of money to boot.

    This cycle is why breaking up Microsoft, as Thomas Penfield Jackson originally ruled in 2000, would have been truly destructive to shareholder value. The company was strong because its products built on each other, and at the root of that strength was the Windows monopoly.

    Microsoft’s Opportunity

    Fast forward to last Monday, and the opening of Microsoft’s Worldwide Partner Conference. COO Kevin Turner put up this slide:

    Kevin Turner's slide at WPC. Curiously, and in contrast to the rest of WPC, Microsoft has not made Turner's keynote available publicly.
    Kevin Turner’s slide at WPC. Curiously, and in contrast to the rest of WPC, Microsoft has not made Turner’s keynote available publicly.

    A monopoly that is not.

    My first reaction to this slide was quite positive, but the more I’ve thought about it, the more I think the slide represents Microsoft’s biggest issue moving forward. It’s not that their devices share is at 14% – that’s just a fact, and I applaud the honesty; rather, I’m bothered by the phrase “We have a big opportunity.” For Turner, the opportunity is in growing that 14%. As quoted by Gregg Keizer:

    We want to go from 14% to 18%, from 18% to 25%, from 25% to 30%. That’s the beauty of this model … [the opportunity] is much bigger than anything we’ve had in the past.

    Turner is still talking about devices, and it’s really too bad, because the real opportunity is in the 86%. Microsoft already has software and services like Skype, Bing, and OneDrive that work right now on 100% of that pie; it’s only a matter of time until the same can be said for Office. That is the opportunity; to even think about the share of devices, particularly at the executive level, is to handicap Microsoft’s greatest chance for growth before it even truly gets started. It’s not just that Windows is no longer Office’s only market that matters; it’s that Windows and Microsoft’s devices focus is actively damaging Office’s prospects.

    Nadella’s Memo

    And so we are back to Nadella’s memo. In contrast to Ballmer’s anything-but-“focus,” Nadella was quite specific:

    More recently, we have described ourselves as a “devices and services” company. While the devices and services description was helpful in starting our transformation, we now need to hone in on our unique strategy.

    At our core, Microsoft is the productivity and platform company for the mobile-first and cloud-first world. We will reinvent productivity to empower every person and every organization on the planet to do more and achieve more.

    Nadella was clear that focusing on “every person” meant focusing on every device as well:

    [Microsoft’s productivity apps] will be built for other ecosystems so as people move from device to device, so will their content and the richness of their services – it’s one way we keep people, not devices, at the center.

    This is exactly right. Nadella is making a choice here: productivity as a single unifying principle, and by extension, services based on people, not differentiation based on devices. Moreover, it’s a far more difficult and brave choice – obvious though it may be – than outside observers could likely understand. It was only a little over a year ago that Ballmer declared, “Nothing is more important at Microsoft than Windows.”

    Last week, Nadella said “No.”

    The Power of Culture

    The problem, though, was elucidated by Nadella himself in an interview with The Verge:

    At the end of the day, look, any strategy gets eaten for lunch if you don’t have a culture that’s also changing.

    Nadella is referencing the famous Peter Drucker3 quote “Culture eats strategy over breakfast”; unfortunately, as we have already seen with Kevin Turner’s presentation, that is almost certainly what will happen at Microsoft. For all the talk of moving beyond Windows (and Windows Phone), I am deeply skeptical that Microsoft can truly pursue its potential as a software and services company as long as Windows is around. Culture is developed over years, and for decades everything at Microsoft was about Windows. Read again Ballmer’s statement:

    Nothing is more important at Microsoft than Windows

    The problem for Nadella and Microsoft is that ultimately this wasn’t a declaration of strategy; it was a declaration of fact, and facts don’t change by fiat.

    Understanding Nokia

    This is how one can really understand why Ballmer – over the objection of Nadella, among others – made the disastrously stupid decision to buy Nokia. We now know for a fact that my speculation at the time that Nokia was about to introduce Android phones was spot-on, and the terms of the deal suggest that Nokia was having financial difficulties as well; if Microsoft would have lost Nokia, they would have lost Windows Phone, and Ballmer saw that as a mortal threat. Never mind that Windows Phone is for all-intents-and-purposes already dead; the thing about culture is that it not only eats strategy, it washes it down with a potent mixture of selective facts and undue optimism.

    In so doing, though, Ballmer dramatically compounded his 2004 error. When Nadella took over earlier this year Microsoft had not only missed the mobile boat, he was now saddled with a $7.2 billion dollar anchor and 34,000 new employees. That’s the thing about last week’s layoffs: even after shedding 18,000 employees Microsoft will still be about 16% bigger than they were before the acquisition, and still tightly bound to a devices group that is working at diametrically opposed goals from the software and services businesses that are Microsoft’s future.

    The Solution

    It was just about year ago that I wrote in Services, Not Devices:

    The truth is that Microsoft is wrapping itself around an axle of it’s own creation. The solution to the secular collapse of the PC market is not to seek to prop up Windows and force an integrated solution that no one is asking for; rather, the goal should be the exact opposite. Maximum effort should be focused on making Office, Server, and all the other products less subservient to Windows and more in line with consumer needs and the reality of computing in 2013…

    As for Windows, let it focus on solidifying Microsoft’s hold on the enterprise (it’s here the need to fight the iPad is most acute), with a nice spillover into Home PCs and gaming, and accept the fact Windows was only ever relevant in the consumer market because nobody got fired for buying IBM.

    In other words, keep Windows as a cash cow, but be explicit that the future was in cross-platform services. Unfortunately, this was before the Nokia deal. The effects of that deal – and understanding why it was made – have convinced me that Microsoft cannot truly reach its potential as a services company as long as Windows and the entire devices business is in tow.

    In short, it’s time to break Microsoft up.

    In 2000, Windows, Office, and Server were a virtuous cycle. Today, Windows and the entire devices business is nothing but a tax. Microsoft is a company that is meant to serve the entire market, and the way to do that is through services on every device. It’s all fine and well to say that you will treat devices equally, but given Microsoft’s history – and the power of culture – I just don’t believe it’s possible.

    I would create two companies: the devices side, which includes Windows, Windows Phone, and Xbox, and let them do the best they can to grow that 14%. Heck, make Kevin Turner the CEO. Windows profits will keep the company going for quite a while, and who knows, maybe they’ll nail what is next.4

    The other company, the interesting company, is the services side – the productivity side, to use Nadella’s descriptor. This company would be built around Office, Azure, and Microsoft’s consumer web services including Bing5, Skype and OneDrive.6 These products don’t need Windows; they need permission to be the best regardless of device.

    Of course, the Windows company does need Office, and Azure, and all the other Microsoft growth engines, and this cleavage would likely hasten Windows’ decline. But that’s exactly why a split needs to happen: anything Office or Azure or Microsoft’s other services do to prop up Windows – that focuses on that 14% – by definition limits Microsoft’s opportunity to address the far bigger part of the pie that ought to be the future.

    1. I’m very puzzled by the URL here: It is “http://www.microsoft.com/en-us/news/ceo/index.html”, which means this email is the de facto home page for Satya Nadella. I presume that won’t be the case forever, but how then will you find this note? ↩

    2. To be clear, from a revenue and profit perspective, the business still is incredibly impressive. Microsoft still makes more revenue and profits than Google. Revenue in particular, though, is trending in the wrong direction, and Microsoft’s decline in relevancy, particularly in the consumer market, is large ↩

    3. Supposedly ↩

    4. One more thing: this devices company would not have killed Nokia’s feature phone business. The “tax” works in both directions ↩

    5. Don’t laugh; the thing with search is that when you reach the tipping point, it can become very profitable very quickly, and Bing is getting closer ↩

    6. Probably the toughest division to split would be the on-premise server groups. On one hand, they make Office go; on the other hand, their incentives and sales patterns aren’t perfectly aligned with Azure and Office 365. I could see arguments on both sides, but would tend towards leaving them with the new Services Microsoft ↩

  • Site Note: Vacation and the Daily Update

    Just a quick note that I am on vacation this week and do not plan on posting an article (although I certainly picked quite the week to be gone!).

    The Daily Update will continue but instead of analysis of recent news, I have written brief overviews of the Strengths, Weaknesses, Opportunities, and Threats (SWOT) of five of the most important companies in tech (all links members-only):

    These will be delivered to members as usual by email, private RSS, or via links on the right side of this page (bottom on mobile).

    To become a member of Stratechery go here; to read through the archive of past Daily Updates, go here (members-only).

    My thanks to all of Stratechery’s readers and especially members for your support. Look for new content starting on Monday, July 21.

  • Smartphone Truths and Samsung’s Inevitable Decline

    For me, anyway, the most surprising thing about Samsung’s disappointing earnings was just how surprised many folks seemed to be. The smartphone market is a massive one, but also rather predictable if you keep just a few key things in mind:

    • Everyone will own a smartphone – I don’t think this is controversial, but it’s important, as there are a few implications of this fact that are perhaps non-obvious.

    • The majority of buyers will prioritize price – The implication of a phone being a need and not a want is massive downward pressure on the average selling price for two reasons:

      • Low income buyers who might normally not buy consumer electronics or other computing devices will be a part of the phone market, and will buy low-priced models by necessity
      • Higher income buyers who are uninterested in other consumer electronics or other computing devices will be a part of the market, and will buy the low-priced models by choice

      The net effect is that the average selling price for a phone will be low and always decreasing, while the high-end market will be relatively small in percentage terms.

    • Absolute numbers matter more than percentages – While it’s natural to talk about market size as a percentage, the absolute size is just as important. In the case of Apple, for example, the fact they “only” had 15.5% percent of the market in 2013 is less important for understanding the iPhone’s viability than is the fact they sold 153.4 million iPhones. That is more than enough to support the iOS ecosystem, percentages be damned.

    • There will always be a high end segment – The very reason why everyone will buy a phone (always with you, access to information, communication) are the same reasons there will always be a segment of the population willing to pay for a superior product. The analogy to cars is perhaps overdone, but for good reason: it makes a lot of sense. Like cars, phones are about appearance, performance, and experience; both are status symbols; and (in most parts of the world) both are necessities.

    • The high end isn’t that expensive on an absolute basis – Where the car analogy breaks down is absolute prices. The cheapest Mercedes-Benz you can buy (in the U.S.) is a surprisingly accessible $29,900. That, though, is 46x as expensive as an iPhone 5S. Sure, an iPhone 5S is a bit more than 3x as expensive as a Moto G, but the absolute price difference is only about $500; a car 1/3 the price of that Mercedes would have an absolute price difference of $20,000.

    • Low end quality is improving rapidly – That Moto G is a very nice phone that absolutely does the job for most people. It’s also not that big a deal, particularly in Asia where there are even cheaper and more capable phones available based on a SoC from MediaTek. Moreover, the entire supply chain continues to improve and bring down prices on every part of a smartphone, improving the quality of even the most inexpensive products.

    • Fleshed-out App Stores are table stakes – By fleshed-out app stores, I mean the iOS App Store and Android’s Play Store, full stop. It’s nice that Windows Phone and the Amazon Fire app stores are getting some big names, but the problem with an 80/20 approach (in this case, shooting for 20% of apps that satisfy 80% of needs) is that everyone differs on the remaining 20%, and it’s usually that 20% that is the most important for any one user. Of course, some users don’t really care, but those are likely super low-end customers anyway, which aren’t great for margins or your ecosystem.

    • Carriers matter, at least for the high end – Many customers, particularly in developed markets, are loyal to their carriers and only choose phones which are available on their preferred network. On the flipside, markets in which people move freely between carriers (or use dual-SIMs) are usually lower-income markets with smaller high end segments.

    • Screen size matters – The one physical characteristic that seems to impact phone selection is screen size. While the large screen phones are a relatively low percentage of the total phone market, they are a much higher percentage of the high end.

    • Software Matters – For years analysts treated all computers the same, regardless of operating system, and too many do the same thing for phones. I personally find this absolutely baffling; you cannot do any serious sort of analysis about Apple specifically without appreciating how they use software to differentiate their hardware. The fact is that many people buy iPhones (and Macs) because of the operating system that they run; moreover, that operating system only runs on products made by Apple. Not grokking this fact is at the root of almost all of the Apple-is-doomed narrative (which, by the way, is hardly new).

      Software-based differentiation extends to apps. While a fully-fleshed out app store is table-stakes, for the high end buyer app quality matters as well, and here iOS remains far ahead of Android. I suspect this is for three reasons:

      1. The App Store still monetizes better, especially in non-game categories
      2. iOS is easier to develop for due to decreased fragmentation
      3. Most developers and designers with the aptitude to create great apps are more likely to use iOS personally

      None of these factors are likely to go away, even as Android catches up with game-based in-app purchases and as iOS increases in screen size complexity.

    It is this final point that makes the Samsung news so unsurprising. Samsung had built up a healthy high-end business by:

    • Being available on nearly every carrier
    • Pioneering the large-screen segment
    • Producing hardware that was meaningfully superior to low-end offerings

    All three of these factors either have or are in the process of disappearing:

    • After a two-year lull, Apple has greatly expanded iPhone availability worldwide
    • As noted above, the gap between low and high-end hardware is disappearing
    • Multiple manufacturers have moved into the large-screen segment, with the iPhone coming soon

    In China Samsung has another problem: their brand and distribution channel, which they have spent billions building, is no match for Xiaomi’s star power which lets the startup sell phones at cost without any additional marketing or channel expenses. It’s not helpful to (rightfully) say this issue is primarily limited to China (I’m more skeptical of Xiaomi’s prospects elsewhere, but bullish on Lenovo) because the Chinese market is the largest market in the world.

    Ultimately, though, Samsung’s fundamental problem is that they have no software-based differentiation, which means in the long run all they can do is compete on price. Perhaps they should ask HP or Dell how that goes.

    In fact, it turns out that smartphones really are just like PCs: it’s the hardware maker with its own operating system that is dominating profits, while everyone else eats themselves alive to the benefit of their software master.

    Previous articles on Samsung’s troubles:

  • Happy Independence Day Mr. Glass

    Blessed with the sort of love him or hate him reputation reserved for the truly popular, Bill Simmons has received a lot of criticism from NBA fans for his propensity to act as the Body Language Doctor: he will make grand pronouncements about players or teams based on nothing more than a player or coach’s demeanor on the floor or in a press conference.

    Still, I can sympathize with Simmons: it’s easy to give in to a similar sort of temptation when you read things like this New York Times article about Ira Glass and This American Life leaving Public Radio International:

    On July 1, “This American Life” became independent, leaving its distributor of 17 years, Public Radio International, or PRI. That change is partly technical. The program is no longer delivered to local stations through public radio’s satellite system, but instead over the Internet through the online platform PRX, the Public Radio Exchange.

    But the big impact is financial. Gone are a distributor’s financial guarantees, which in the case of “This American Life,” reached seven figures. Instead, Mr. Glass will now be responsible for the show’s marketing and distribution, as well as for finding corporate sponsors. It’s the equivalent of Radiohead’s releasing its own album “In Rainbows,” or Louis C. K.’s selling his own stand-up special — except all the time, for every show. It’s the kind of move that can signal radical changes in the public radio firmament, with National Public Radio and other distributors wondering who, if anyone, may follow suit, and whether Mr. Glass will return if he fails.

    “You take on the risk if you have to do the marketing,” said Laura Walker, president and executive chief officer of New York Public Radio, which operates WNYC. “I don’t think it’s a slam-dunk way of making money. You’ve got to put in a lot of effort and do the work yourself.”

    Set aside the implications for Glass and This American Life for just a moment: what is striking about the article, and this section in particular, is that there is zero discussion about upside. The “big” financial impact is the foregoing of financial guarantees, and questions are raised about what happens if Glass fails – but not if he succeeds. There is concern that Glass’s move towards independence is not a “slam-dunk way of making money.”

    To be fair, this is only one article, but the reason the body language doctor angle is so tantalizing is that this approach seems very representative of traditional journalism’s general discomfort with the Internet. When your world is collapsing it’s awfully easy to see only the downside, and to wish that things like disruption did not exist.

    So let me provide a counter-narrative, and re-write the lede to this story:

    On July 1, just days before the country he chronicles marks Independence Day, Ira Glass of This American Life celebrated his own independence, leaving his distributor of 17 years, Public Radio International, or PRI. That change is partly technical. The program is no longer delivered to local stations through public radio’s satellite system, but instead over the Internet through the online platform PRX, the Public Radio Exchange.

    Of course This American Life is no stranger to Internet distribution; while 2.1 million people listen to the show live on the radio, another million download the podcast, making it the most popular show on Apple’s iTunes. In fact, it was Mr. Glass’s ability to connect directly with his show’s listeners that made an intermediary like PRI redundant.

    To be sure, Mr. Glass is taking a risk by abandoning a distributor’s financial guarantees, which in the case of “This American Life,” reached seven figures. Instead, Mr. Glass will now be responsible for the show’s marketing and distribution, as well as for finding corporate sponsors. The upside, however, is enormous. The cost of a financial guarantee is limited upside – that is why distributors take on that risk – but by taking control of distribution Mr. Glass is reserving that upside for himself.

    “The entity with the most to lose in this move is not This American Life,” said Ben Thompson, who has written frequently about the impact of the Internet on journalism at his blog Stratechery. “Rather, once other radio personalities realize that the Internet has made distributors redundant a lot more people are going to question why they don’t take control of their own destinies.”

    The clear winners, though, are consumers: Mr. Glass has marked the occasion by releasing a new podcast called Serial, and it will be available to everyone worldwide, no distribution deal needed.

    Happy Independence Day to Ira Glass.

    And, dear readers, Happy Independence Day to you as well, both you in the U.S. actually celebrating the holiday, and also everyone around the world who I can reach with ease, no distributor needed.