Apple’s services strategy
The infernal spiral of differentiation and monetization
Cemeteries are full of companies that didn’t understand the power game.
Apple's service strategy meets two objectives:
make its hardware (IPhone, IPads, etc.) as exclusive as possible
monetize it as much as possible
Apple applies 100% of the theory of exclusivity developed previously and which can be summarized by this graph:
The theory of exclusivity
This theory postulates:
The more exclusive a property is, the more desired its possession is. And its corollary is also verified: the more substitutable a good is, the more indifferent one is to appropriate it <...> The possession of an exclusive, scarce good gives power and constitutes a sign of this power. No one can encroach on this property or appropriate it. The ownership of an exclusive property distinguishes the individual from his or her peers. The will to power being intrinsic to man, it is not surprising to see this propensity to hold exclusivity. In contrast, what is common, abundant, common is only valued for its utilitarian aspect, so it can very well be rented or borrowed.
A classic way to exercise this power is to extract a rent from it. Goods naturally have different degrees of exclusivity: at the top of the chain are lands, which are both a monopoly on space and time. It is not surprising that the struggle for territory has always provoked wars, revolutions and crises (2008). The aspiration to own one's own home is such a concern that it is at the heart of governments' economic policies in Western countries: going against it is like losing elections.
Companies, like individuals with land and ownership of their sweet home, also seek to establish monopoly positions to exercise their power, but they must build them and it is harder (except for companies based on scarce resources like DeBeers or Aramco). Very advanced companies, often in the field of technology, can create a unique product. Once their monopoly is built, they seek to exploit it by extracting a rent from it. This thirst for monopoly goes against capitalism, whose raison d'être is precisely to promote progress by fighting against monopolies, but it is always latent. IBM in the 1960s: the company integrated hardware and software and had a monopoly on computers. Why sell them? It was more appropriate to extract a rent from them by renting them out. Customers had no choice, no alternative offer of computers existed. Then IBM gave up for fear of antitrust law and separated its various activities, paving the way for Microsoft.
Microsoft has jumped into the breach and built another monopoly based on standardization. The company has found a slightly different tactic to exploit its advantage. Instead of renting his operating system and services (which he does now), he sold the licenses but made them obsolete very quickly, forcing him to buy the new version. It's about the same as a rental: Microsoft didn't lose its monopoly by selling its software, since it recreated it right after. Designing and selling a new version every three years was like receiving a three-year pension. Microsoft has changed its business model in recent years: having lost the monopoly of standardization, the PC becoming the smartphone's accessory, it has regained a form of exclusivity through its cloud offer. This exclusivity is based on a unique and substantial real estate asset (its server base) allowing it to extract an annuity through subscription formulas.
Apple, for its part, has succeeded in building an exclusivity based on the integration of its hardware (IPhone) and software (IOS). Finally, like IBM in its early days, Apple created a new category where the integration of software and hardware provided a real advantage to the user (essential fluid experience on a small screen). When a category is new, integration makes sense between its components, then over time, the components are standardized until they are intertwined. Clayton Christensen developed this theory:
Modularity theory (also known as interdependence and modularity theory) is a framework for explaining how different parts of a product's architecture are linked to each other and therefore affect production and adoption metrics.
A product is modular when there are no unpredictable elements in the design of its parts. Modularity standardizes the way components are assembled - physically, mechanically, chemically, chemically and so on. The parts interlock and work together in a well understood and codified way.
A product is interdependent when the way in which one part is manufactured and delivered depends on the way in which the other parts are manufactured and delivered. The interdependence between the parties requires that a single organization develop both components if it hopes to develop one or the other.
Once a product or service is reliably delivered to customers, individual parts and their interactions become standardized. This creates a state of modularity in which many suppliers can compete to deliver one or more modules faster and at a lower cost. Interdependence and modularity are not binary notions; they are part of a continuum. It should be recalled that the implementation of modularity or interdependence does not determine the adoption of a product, but predicts how quickly it will be adopted.
Apple has therefore created a "monopoly" of the high-end smartphone based on software/hardware integration. The question then becomes that of monetization. Rather than offering its iPhones for rental (like IBM in its early days), Apple has preferred a model of sales (more judicious towards its high-end customers) and programmed obsolescence, by constantly improving hardware and software. This has the advantage of preventing modularity from gaining ground in the end. This is what happened to IBM, which had "fallen asleep" on its monopoly and allowed standardization to progress. Apple now has two weaknesses that its services strategy aims to address:
a limit to the monetization of hardware: the small technique of programmed obsolescence no longer works very well: Iphone users tend to keep it longer. The renewal cycle of Iphone 6 is still in progress. To compensate for this phenomenon, Apple has raised its prices since Iphone X, but at the risk of locking itself up on its best customers. This strategy is untenable and Apple is already going backwards. The following graph shows the positioning of the different generations of Iphones in terms of price:
If Apple can hardly raise the bill on hardware, it can on services using its installed base (almost 1.5 billion devices). All he has to do is highlight his services on the devices to extract his pension, even at a lower service level . Apple has 420 million subscribers to one or more of its services, or one in three users. There is still room for improvement.
The differentiation of hardware by software is fragile: until when will integration bring a plus? A really innovative new hardware will make the previous integration unnecessary (we can think of augmented reality glasses for example). As Clayton Christensen says, history shows that integration through attack eventually gives way to another integration at another end of the chain. Apple must be careful not to be surprised and to strengthen its integration by extending it. Services can play this office provided that they are exclusive to Apple and that they enhance the hardware.
the examples
Let's analyze some Apple services according to these two aspects:
Apple TV+ does not specifically reinforce the Ipad or the Iphone. It does not bring anything to the hardware compared to Netflix which is at least as fluid. It can indirectly contribute to selling IPads and iPhones because Apple offers the service for free for 1 year to buyers of new devices; but as Benedict Evans says, Apple could do the same with a slice of pizza. The family aspect of Apple TV+ could be used as an argument to buy an Apple product rather than an Android product, but Disney does better and is available everywhere. So Apple has to fight over the price, a hell of a lot! Bob Iger’s recent resignation from Apple's board of directors is no coincidence... Apple TV+ is a very good way to monetize. On the one hand, the family price is very low, which should lead to strong adoption on the installed base. The following table shows the leverage effect on the installed base:
In addition to this revenue at zero marginal cost, Apple will sell third-party subscriptions (Starzplay, Showtime, etc.) within Apple TV+ that will be pure margin because "forced to go through the Apple monopoly" for their distribution. So Apple TV+ : differentiation 0, monetization 1.
Arcade: this is Apple's game offer at €4.99 per month, half as expensive as Stadia. Apple integrates 100 exclusive games at the beginning and the number will increase every month. These games exploit the technical possibilities of the new IPhones and enhance them. Moreover, the exclusivity of games is much higher than that of movies: a game can last for years and attract generations of fans (see our article on NetEase) while a movie lasts 1h30 and quickly loses its value. Arcade exclusivity is far superior to Apple TV+ exclusivity. Finally, the icing on the cake is that a video game is increasingly a disguised social network, which implies a need to protect privacy. Apple is very well positioned on this point compared to Google. This de facto strengthens Apple hardware over any Android device. Arcade is an excellent way for Apple to extract rent: the marginal cost of each new user is almost zero (the production costs of the games being fixed). Addiction and zero marginal cost combined with a very low acquisition cost (application clearly visible on the screen) are the recipe for great success. differentiation 1, monetization 1
Apple Music: this offer does not bring any particular value to the hardware. Spotify also does the same, Amazon Music too, the three depend on labels catalogue. We're not going to buy an IPhone to subscribe to Apple Music. The monetization of the application on the other hand, even if it is less important than that of Arcade or Apple TV+ remains appropriate: after labels royalties (variable fees), Apple keeps about 30%, but as the acquisition cost is low, and the churn is probably also low because Apple Music gives Apple Music an advantage of fluidity over its competitors on all its hardware (in particular the ability to switch from the iphone to the Watch and the AirPods or the Beats headphones). Differentiation 0, monetization 0.5.
The App Store brings great differentiation, especially to the iPhone, and this since its launch on July 11, 2008. The App Store launched with 500 applications at the beginning was a stroke of genius by Steve Jobs giving a magical aspect to the iphone, which like a chameleon could adapt to any environment and provide infinite services with great fluidity. The App Store is an important vehicle for the success of the iPhone. It now includes 2 million applications running smoothly. In addition, the App Store is perceived as protecting privacy, which is not the case with Google Play Store. The application store has become the vital part of a smartphone, so there are two reasons to prefer an iPhone to an Android phone. Apple levies its 30% tax on any sale of digital products through its platform. Application developers are required to pay if they want to access the installed base. Apple is now applying the recipe of the App Store to the Watch, with the creation of an App Store dedicated to the Watch and independent of the IPhone (WatchOS 6). The Watch could become the new center of gravity of the Apple ecosystem, it is important to differentiate it. Differentiation 1, monetization 1
The conflict
All Apple's ambiguity is there, in the tension between differentiation and monetization. In theory, greater differentiation makes it possible to monetize better within the limit where the buyer perceives that he receives more than he gives. The problem is that differentiating hardware by services is hard, harder than by software: the easy solution for Apple is to break the prices of its services to "force" adoption, as the company generally is late in the game. The annuity is disguised: low price but limited content. When you exceed the limit and start extracting a pension that is too visible, unpleasant consequences will eventually occur:
increase in substitutions
intervention by competition authorities to break the rent
Therefore Apple must further strengthen the differentiation it seeks to monetize: the infernal spiral. Apple is at a crossroads: seeing that hardware has reached a peak of monetization (users tend to stay with their old models), the company goes backward. It now relies on services to further differentiate hardware (with varying degrees of success), and to shift its monetization. But
this does not leave competition authorities insensitive (Spotify/Apple music case, App Store case)
despite Apple's best efforts to lock the customer through multiple services (security, payments, etc.), a tactic used by Microsoft in the 1990s, a technological advance could shift demand to a different ecosystem and other integration. This will be all the more true if the quality of services leaves something to be desired.
And fortunately in a capitalist system, exclusivity in most cases is only relative: Apple's greed can lead to its loss.