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Perspectives on building technology businesses and AcceleratorIndia from Cartezia

Apple's multi-prong strategy pays off

Monday, March 31, 2008

Apple's multi-prong strategy, hatched in the tough times from 2001 to 2003, is now paying off handsomely. In those difficult days when revenues stayed stubbornly flat, and margins hovered around zero, Apple re-invented its core Mac range of computers, and launched the iPod and iTunes to become a major player in the Consumer Devices and Services space. In 2007,45% of its revenues came from this consumer business. Although iPhone sales only accounted for 0.5% of revenues in the same period, it's launch marks a continuation of this successful strategy.  

In spite of the buzz around iTunes and the iPhone, Mac desktops and portables still account for over 40% of Apple' s revenues, and the recent launch of the ultra-thin MacBook Air notebook computer reinforces Apple's determination to maintain it's strong position in the graphic arts industry.  Apple's growing revenues, however, are largely due the success of its consumer device and service strategy underpinned by the iPod range of devices.




iPods and iTunes now account for 50% of Apple's revenues

In 2007, iPods accounted for nearly 35% of Apple's revenues, and although sales of this range of products grew more slowly, iTunes revenues continued to grow, and now constitute over 10% of all revenues, growing from zero to over $2bn in the space of 4 years.



The iTunes store sold it's 4 billionth song at the beginning of 2008 and it has now sold
125 million TV shows and 7 million movies, since adding this product category to the store early in 2007. Apple is now adding Movie Rentals to iTunes, which includes titles from six major studios and five other studios. Walt Disney, Universal, Sony, Twentieth Century Fox, Paramount and Warner Brothers have all signed up, and titles will be available 30 days after DVD release. Apple has also launched an update to Apple TV via its set-top box, which allows movies to be watched directly in the lounge without a PC.

The iPhone could transform the Mobile Phone Business Model

Apple's new iPhone, launched with great hype in 2007, has the potential to transform the mobile phone market by changing customers expectations about what to expect from mobile phones.  The first version of this device has some shortcomings, which no doubt will be addressed in subsequent products:

  • It supports 2G, not 3G, which reduces the ability to surf web-sites and access content over the network. Graphics and picture-heavy sites, in particular, are slow to load
  • It lacks Instant Messaging and Voice-over-IP capability
  • It lacks the ability to sync data, such as contacts and diaries
  • The built-in camera performance is disappointing and only offers 2 Megapixels resolution
  • It only has 8 Gb of flash memory, which cannot be added to

The iPhone's real differentiation, however, lies in its marriage of touch screen and user interface. The various functions have been knitted together in a way which rises above all the competing offerings based on cluttered menu-based navigation.  The touch-screen interface which allows users to flick easily between artists, playlists, contacts and pictures is likely to set the new standard which competitors will try to emulate. The underlying phone operating system, Mac OS X, is also more robust than other systems, which crash from time to time. And each iPhone, of course, is also a fully-functional music and video player which syncs with iTunes.

Apple's success with the iPhone depends crucially on its ability to change the business model in the mobile phone industry. The prevailing model is based on the manufacturers selling to the service providers, typically the large network operators. The service providers subsidise the initial cost of the handset acquistion for consumers, by locking them into long-term service contracts, which effectively recoup these subsidies and make large margins from the ongoing provision of services.  The problem with this model for consumers is that they are left with obselete products or locked into a series of recurrent  service contracts with the service providers.
 
Apple's business model is based on selling to consumers, not network operators. What this means is that the iPhone itself is not subsidised, but its higher cost reflects the fact that it is designed to be long-life platform, on which Apple will deliver a growing set of services. Crucially, Apple has managed to persuade a single major network operator in each of the major markets to partner with it and give it 10% of the revenues generated from iPhone users (AT & T in the US, O2 in the UK).  In line with this approach, Apple is also accounting for iPhone sales based on subscription accounting, with revenue recognition spread over 24 months.

Apple's strategy with regard to the provision of new applications and services is also interesting.  It is clearly determined to deliver and charge for core services which harness the native operating system itself and so will not publish an SDK for 3rd party developers.  However, Apple is also using Ajax to deliver some of its own iPhone apps, and supports an Ajax web strategy for custom iPhone applications. Interestingly, Google has praised iPhone's Ajax development platform, because Ajax is what Google uses to deliver nearly all its applications, from Docs to Gmail to Reader.  In the mobile space, Apple is clearly laying the groundwork to secure future service revenues.