Synergies and network effects

It is possible that Steve Jobs planned all along to open up the iPod and iPhone programming interfaces and allow more open use of the iPhone beyond a few select partners. The reality is that Apple finally seems to have figured out how to create synergies and powerful network effects across its products and complementary services (see my earlier column “The Evolution of Platform Thinking,” January 2010). The iPod, iPhone, and iPad devices, as well as the i Tunes service, all work particularly well with the Macintosh computer, and have some interoper-ability with Windows. And providing its own essential complements—like Microsoft has always done for DOS and Windows—has become critical to Apple’s success. Apple’s products, despite their elegant designs and unique user interfaces, are not very valuable without external digital content such as music and video files and a variety of applications and accessories. Apple cleverly found a way to provide the key complementary platforms itself—the i Tunes Store and the Apple App Store, and now an iBooks store. Moreover, these are automated services, with low costs and high potential profit margins. Apple is being smart and encouraging the ecosystem development by sharing most (about 70%) of these revenues with the content owners and application developers.

Apple’s financial break with its past is truly astounding (see the table on the preceding page of this column). In 1995, Apple was nearly twice the size of Microsoft in annual revenues ( approximately $11 billion to $6 billion) but its market valuation was only about 40% of revenues. By contrast Microsoft’s value was nearly six times revenues —reflecting Microsoft’s greater growth prospects as well as operating profit margins that were also about six times Apple’s (35% versus 6%). Indeed, Apple shrunk in subsequent years whereas Microsoft’s sales exploded as Windows 95 became the basis for a new generation of desktop PCs as well as Internet-enabled consumer and enterprise products.

When iPod sales began to surge in 2005, Apple’s revenues, profits, and valuation also began to surge. In fact, by moving beyond the computer business and into consumer electronics

in the long run,
the most valuable
part of the apple
franchise might
end up being its
online services
and content
platforms (itunes
and the app store).

and then mobile phones, Apple’s revenues have risen several times faster than the overall PC industry. Its sales jumped from $6.2 billion in 2003, with an operating loss, to over $36 billion in 2009, with a 21% operating profit margin. In addition, Macintosh computers in 2009 made up only 38% of Apple’s revenues, down from 72% in 2003. The iPod accounted for 22% of 2009 revenues, music products 11%, and the iPhone approximately 18%. Software and services as well as hardware peripherals generated the other 12% of sales. It is striking how Apple’s market value remained less than its annual revenues for so many years while Microsoft’s market value was 8 to 13 times revenues. But here too, by 2005, the tide had turned. Apple’s value has continued to rise, reaching five times revenues by the end of 2009 and then finally surpassing Microsoft, whose value has been flat or dropping for a decade due to commoditization of PC hardware and software and its inability to move much beyond the PC. In particular, Microsoft’s attempts to emphasize tablet computers as well as copy the iPod with the Zune digital media player and compete in smart-phones with Windows devices have failed miserably.

current Situation

Not everything is completely smooth for
Apple, however. The company has been
clashing with Google and its rival mo-
bile OS (Android). Google is the cham-
pion of open systems and always tries
to force semi-open or semi-closed plat-
forms to “open up” so that it can get un-
restricted access to information on user
behavior through searches and thereby
sell more and better targeted ads. Apple
is also clashing with Adobe, refusing
to support the Flash technology on the
iPhone or the iPad, even though Flash
is used for the vast majority of videos
and advertisements on the Web. The
U.S. Department of Justice and the Fed-
eral Trade Commission are reportedly
reviewing Apple’s restrictive policies to
see if they violate antitrust laws.e Apple
has near-monopoly shares (approxi-
mately 70% or so of the market) for both
digital devices (iPod) and digital con-
tent services (i Tunes). But, for the mo-
ment, users continue flocking to Apple
products because of their elegance and
the superior user experience.

 

e J. Kosman, “An antitrust app: Apple may be in the eye of a regulatory storm,” New York Post, May 3, 2010; http://www.nypost.com/

 

Michael A. Cusumano ( [e-mail]) is a professor at the Mit sloan school of Management and school of engineering and author of Staying Power: Six Enduring Principles for Managing Strategy and Innovation in an uncertain world (oxford university Press, 2010).

copyright held by author.v