Apple moves downmarket: iPhone as a services platform
Coincident with the launch of the iPhone 3G hardware, Apple has started a couple of new online services: MobileMe and the iPhone App Store. In some ways these are natural extensions of existing product lines. But
I believe their launch actually represents a fairly substantial strategic shift as Apple attempts to diversify from a hardware-only company to one that runs on a mix of hardware and services. In order to make this strategy work, Apple will need to sacrifice its much coveted high hardware margins.
Diversifying from hardware
Since Jobs pulled the company out of the doldrums, Apple has been a manufacturer of high-end hardware. This is a very nice place to be. Their margins are very high. If you compare the hardware bits that go into a Mac to those in any PC, Apple’s prices are much higher. PC manufacturers squabble over low single digit margins because their product is almost completely commoditized. HP, Dell and IBM struggle to differentiate themselves in the market.
Meanwhile Apple can charge a hefty premium for good industrial design and software that is slicker than windows. iPod followed in this tradition of high margins by setting the bar for usability in portable
media devices and following up with fantastic marketing.
Being a niche retailer of high-end products is a comfortable and stable place to be. However, having a single line of revenue isn’t good for a large company, so diversifying makes a lot of sense. Thus Apple’s current push into services.
The iTunes music store was an important pre-cursor to the current push into services. Even though iTunes moves a massive volume of music, if you work through the accounting confusion, they’re not actually making much money there. Because the established music industry giants are completely fucked and have no idea what to do, they drive the margins of all big online retailers down to a pittance. But iTunes did something very important for Apple: it established a billing relationship with customers. Cellular operators have this kind of ongoing billing relationship with their customers which enables them to push high margin, low utility products like ring-tones. Similarly, people are used to spending small quantities of money in iTunes to get music. So iTunes is the perfect precursor for an App Store. In this way, Apple doesn’t even need to rely on the carrier’s billing relationship
to build a services business. This will be very important for Apple in coming years as carriers increasingly become just another provider of wireless bandwidth. In the coming decades, the value will not come from piping bits around. It will come from the services built on those pipes.
MobileMe is a very Apple service
MobileMe is a cloud-hosted email, contact and calendaring solution. There’s nothing revolutionary about this. Google offers all of these services for free. By charging for these services, Apple is implicitly promising to provide a better solution. Considering their vertical integration into popular hardware, it’s not hard to imagine that they will succeed at this. Google will probably remain committed to supporting open standards for working with hardware. By using proprietary protocols, Apple can provide a higher-quality product and support it better on the few platforms they care about. It’s a classic story we’ve seen in this industry before.
MobileMe’s launch was a disaster. This isn’t surprising as Apple is yet to demonstrated great skill in online services. Personally I believe they’ll figure it out, because it’s important to their long-term objectives, and they’re a smart company, and the skills to do this well are getting easier and easier to find. But from a marketing perspective, MobileMe is nothing new for Apple. Because MobileMe is a premium service for which there is a very good free alternative, MobileMe still targets Apple’s classic market segment. They’re still targeting people who are willing to pay extra to have something really polished. They can stick to their classic bag of tricks, like the ads that make fun of people who aren’t as cool as the mac devotees.
App Store is new: a platform play
App Store on the other hand is going to be much harder for them to pull off. For App Store to succeed, their primary challenge is not to attract paying customers, but developers. Because independent software developers (ISVs) are the ones who are actually creating value in the App Store. App is just a distributor taking a cut on that. So what attracts developers to the App Store? Customers do.
It’s a real chicken and egg problem. Nobody’s going to build software unless there are customers to buy it, and it’s hard to get customers without cool apps. Well right now Apple has the whole farm, but it’s a very small farm. There are millions of iPhones out there, representing potential customers. Moreover, the iPhone SDK is very rich and capable when compared to its competitors. Qualcomm’s BREW, Windows Mobile, Palm OS, Blackberry and Symbian have all faltered for one reason or several. Google’s Android holds much promise and hope, but at this
point it’s complete vapor-ware. So for now, Apple has almost all the mindshare of mobile application developers.
But how long will this dominance last? Software platforms are natural monopolies, meaning the economics tend to be winner-take-all. The chicken and egg “problem” can easily turn into a virtuous cycle, pushing a winner to the top. Application developers are fickle and will code to whatever platform has the best distribution. iPhones are very popular, but they are still only used by a small fraction of all mobile subscribers. Until the distribution of iPhones reaches a critical mass, their dominance as a mobile application platform is very shaky.
The mobile app challenger is HTML
Apple’s challenge is to make the proprieray iPhone SDK compelling to developers. The alternative is to build a web application that works well on webkit, and works on every high-end phone. They can attract developers in two basic ways — make the native features of their SDK more compelling, and provide a large market for distribution of the applications.
Charging for distribution of these applications is a gimick that won’t last long. Soon all the interesting applications will be free, but tied to cloud services that have their own business models independent of the mobile client. Premium applications will start to seem a lot like premium ringtones pretty fast. Still, it will help bootstrap this market for Apple so long as there are no serious competitors.
To stay on top, iPhones need distribution quickly
One thing that ties all these points together is that Apple’s continued success with App Store hinges on having wide distribution of iPhones. They are currently throttling the distribution of iPhones for some reason, possibly
because of software glitches. But the aggressive $199 pricing is clearly aimed at attracting a new larger customer base that will help maintain their dominance in the mobile application space.
Long term they might be happy getting by offering premium versions of applications that are freely available on the web. But something tells me they’re actually trying to break open the mass market on this one. This is Jobs’ big play. It’ll be really interesting to see how it works out once Android hits the streets.