How Apple Is Changing the PC Software World… Back
September 11th, 2008
Daniel Eran Dilger
Despite Apple’s current successes, it seems that nine out of ten pundits agree: Apple needs to change its hardware-centric business model to copy the software-oriented success that Microsoft saw in the 90s, or die trying. They’re wrong, here’s why.
.
The Software Surprise.
In the 80s, the early PC world was quite surprised to discover that software turned out to be more important than hardware. Everyone in the 80s (Apple, Atari, Commodore, IBM, NeXT, and all the PC makers) thought that building hardware was going to be the way to make money.
By the end of the 80s, we’d figured out that Bill Gates had happened to be in the right place at the right time to dominate the PC industry and lead it into a truly awful place, where everything was ugly and buggy and insecure and unstable, and we had to pay him to keep the system going.
However, Microsoft is now running into problems with its software-centric model, and Apple is demonstrating a new model that works better. It’s actually the same model Apple pioneered in the 80s.
SCO, Linux, and Microsoft in the History of OS: 1980s
Office Wars 1 - Claris and the Origins of Apple iWork
Office Wars 3 - How Microsoft Got Its Office Monopoly
The Problem with Retail Software Profiteering.
Gates recognized early on that domination of the PC industry through retail software was not going to be sustainable. After selling Office for $500 for years, it’s now competing against free alternatives that have hammered Microsoft’s ability to extort vast sums of money in exchange for basic functionality.
Microsoft has been working frantically for decades to figure out the elusive trick of how to turn retail software sales into subscription sales, because all retail sales will eventually be eroded by competition as the market, even when battered by anti-competivie restraint of trade thugs, will eventually climb back up like the movie hero and act to correct things before the titles roll.
It’s simply impossible to make huge margins on high retail prices and hold off competitors forever. Market forces will act to erect competition, driving prices down until consumers relax. At some point however, low prices can act as a barrier to competition, instilling the sort of market pressure WalMart has propagated: low prices, high volumes, and sustainable profits that are hard for others to match.
Microsoft’s Barrier to Competition.
The closest Microsoft has come to setting up such a defendable retail model is its OEM deals. Every PC sold brings in revenue to Microsoft, and nobody else can muscle into the OEM game to compete against it because those contracts act as great barriers to entry. No functional market means no competition and no reduction in prices.
This has resulted in making Microsoft weak (as a lack of competition always does), but it still works because the correcting actions of market forces are denied through low prices and volume contracts. NeXT, OS/2, and BeOS couldn’t match Microsoft’s low, low prices in high volumes.
Apple can’t today, and even the free Linux is finding it nearly impossible to compete against a product that is priced so low it appears to be free, while paradoxically being one of the highest priced components of the PC, and certainly the one that has historically resisted lowering its price the most: the Windows license.
Windows 95 and Vista: Why 2007 Won’t Be Like 1995
Selling Hardware Through Software.
Two decades past the 80s, Apple is still a hardware company and makes the vast majority of its revenues selling iPhones, iPods, and Macs, not iTunes downloads or iLife or Mac OS X sales.
Pundits witnessing Microsoft’s exploitation of the PC market seem to think there is room for multiple monopolists, and regularly invite Apple to fail in trying assume the impossible, nonsensical role of “monopolist number two” by launching the same software business that failed to work for the Palm OS, not to mention the classic Mac OS a decade ago.
However, what they haven’t figured out is that Apple has a discovered a business model that works better than restraining trade in the software market through monopolized low OEM prices. Apple is using low software prices to return the software business to what we thought of it in the 80s: a lubricant for hardware sales in a vibrant competitive hardware market, not a viral layer of monopolizing control that prevents competition.
The Egregious Incompetence of Palm
Rewriting the Rules of Software.
Apple has set up three new markets for competitive hardware, lubricated by low cost software in the form of iTunes music, videos, and mobile software. Apple’s iPods, iPhone, and Apple TV hardware all have a variety of competitors.
Interestingly however, they do not really seek to set up competitive software markets, as while there are alternative sources of audio and video content and even unofficial iPhone software, there is little room for competition in the low priced content market, too little to sustain PressPlay and Duet and PlaysForSure and most every other music store outside of certain niche markets.
Microsoft also can’t climb into iTunes and dominate Apple’s hardware sales with viral monopolizing, and its independent efforts to spread the Windows model to its own set of music players, mobile phones, and PDAs have all failed as well. Apparently the Windows model only works when you are handed a monopoly from the start by a gigantic outsider entering the market. Unfortunately for Microsoft, there really aren’t any IBMs left.
Rise of the iTunes Killers Myth
Is Number Two Amazon Rivaling iTunes in Music Sales? Haha No
Installing Competition Where Competition Failed.
Additional layers of apparent paradox appear in Apple’s content business. iTunes’ competitors, and particularly PlaysForSure, all largely failed to compete because there wasn’t enough of a market to sustain multiple options for buying the same stuff.
In an attempt to replicate its Windows PC monopoly, Microsoft set up fake competition that pitted hardware makers and music stores against each other, while all of them were simply reselling Microsoft’s designs and DRM. The PlaysForSure market was no more of a genuine market place than than various food kiosks at Disneyland.
Apple did just the opposite: it sells music, videos, and mobile software from a variety of producers, not to skim off all their profits in a fake market, but with the intent of creating ambiance and foot traffic.
Rather than running a bunch of seemingly differentiated Disneyland eateries like Microsoft’s PlaysForSure, Apple’s iTunes is run like a neighborhood farmers’ market, where goods from a variety of participants are sold to consumers in one place with minimal overhead, not to make a killing, but to create a vibrant destination.
A farmers’ market can’t be turned into a vast profiteering enterprise without destroying it, nor can multiple farmers’ markets compete to the death in the manner of big box retail stores. This has confused the pundits, who have sought to brand iTunes’ success as a “monopoly,” as that is the only world they know.
The iTunes Monopoly/Failure Myth
Evicting Microsoft from Monopoly Control.
In music, video, and mobile software, Apple has taken monopoly control away from Microsoft; it has forced competition into software, turning the tables on the PC model to make software the high volume, low priced commodity sale and hardware the necessary bit to run it.
In Apple’s farmers’ market model, the record labels, movie studios, and mobile software developers, just like the PC makers under Microsoft, are happy to play along because they’re making far more money in iTunes than they were when there was no association governing the music, video, and mobile software downloads market.
Apple’s iTunes has turned attention back to hardware. Apple will eventually bring this model back to the PC world and finish off Microsoft’s monopoly there, too.
High Margin, Low Revenue vs Low Margin, High Revenue.
Microsoft’s efforts to sell its software automatically with every new PC resulted in fat, high margin but low revenue sales. PC makers pay around $30 for an OEM Windows license on a new PC, but Microsoft’s Windows margins are around 80% (81% last year).
Those sales were basically a subscription sale, as PC users would always buy another PC running Microsoft’s software because there wasn’t really any choice. Microsoft doesn’t make any other significant money on PCs outside of Office sales and some accessories, both of which it has worked to tie into OEM sales to prevent competition from developing.
Apple’s hardware sales (at a lower 35% margin, but on a $400 device or $1500 average computer sale) are recurring by user loyalty, not due to a lack of competition in the market. Even in markets where it dominates, there are plenty of viable alternatives. Apple is also getting a cut of music and mobile apps, although this is small and is really only intended to maintain self-sustainability.
Microsoft’s Outrageous Office Profits
The Brittle PC Monopoly vs the Flexible Mac Market.
Apple’s business model makes a lot more sense, particularly as it scales up. And it is scaling up. Microsoft has to own the entire PC market and can’t lose any of it to competition because doing so will have a massive impact on its high volume, high margin, low revenue, low competition business. It will simply fall apart.
Change any of those factors apart from revenues (lower sales volumes or margins, or introduce competition), and everything goes south quickly. Microsoft’s efforts to boost revenues by raising the price of Vista were also unsuccessful.
Apple’s high volume, low margin, high revenue, high competition model is resistant to losing volume (competition is already there, with no visible impact on Apple’s ability to grow), and resistant to losing revenue (because revenue is high with existing competition in place). And of course, if margins go up or competition goes down, that’s certainly not a problem for Apple either.
Changing the Model of PC sales.
I believe Apple is changing the model of hardware and software sales to one that is resilient to competition, and therefore far stronger than the last two decades of Microsoft’s software domination, which required attacking software competitors and destroying upstarts (Java, the web, Linux) before they could challenge Windows.
Apple’s model is also far more profitable, as is obvious from the fact that Apple makes half the revenue and a quarter the profits of Microsoft while only servicing a market that is roughly 4% that of the entire worldwide Windows PC market.
As Apple doubles in size, it will eat up volume sales from Microsoft, converting $40 Windows OEM sales into a $1500 Apple hardware sale. Apple’s margins on a $1500 PC might be around $450, ten times as much as Microsoft on a single sale.
Apple can also sell users a $99 MobileMe subscription, a $99 ProCare subscription and a roughly $99 annual AppleCare subscription, making each sale even more profitable. Incidentally, that’s the subscription angle Microsoft couldn’t figure out.
Apple doesn’t have to cheat the system or to flaunt the law to beat Microsoft. It doesn’t have to stifle competition or overcharge customers. In fact, if it does, Apple will simply lose sales to competitors. Competition has made Apple stronger; its direct competitors, the PC makers, are conveniently all tied to Microsoft’s software anchor.
Apple also doesn’t have to attack open source, interoperability, or open standards, as all those factors contribute to a competitive environment that helps erode Microsoft’s monopoly and creates new opportunities for Apple. It certainly doesn’t care if users install Linux on their Macs. Apple even assists users to install Windows. Apple isn’t afraid of competition, it’s only afraid of closed markets dominated through restraint of trade.
There’s something else Apple is likely to do, and that’s represented in the the iPhone Apps Store, which the next article looks at.
Microsoft’s Unwinnable War on Linux and Open Source
Symbiotic: What Apple Does for Open Source
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25 comments
Dan,
Good piece and a good answer to this drivel posted over at Ars Technica…
http://arstechnica.com/articles/culture/opinion-apple-os-marketshare.ars
Guys who write this rubbish have no business sense - they only equate success with size and have no clue that success is really about margins and profits. Apple gets a quarter of the profits of Microsoft with only 4% of the market? Sure… they’ve clearly got it all wrong…
The differing business models of Apple and Microsoft are really crying out for some in-depth business analysis and review. Something the Harvard Business Review could tackle maybe?
Anyway, unless everyone else has missed it, the new Genius tool in iTunes 8 is another way that Apple is driving revenue and margin from existing customers without having to ‘rape and pillage’ them. Apple now has a new way of driving traffic to the iTunes store and into the hands of artists and content providers - who wouldn’t want to be on iTunes?? And only 65 million customers served - that’s the population of France if anyone is wondering….
Apple’s business model is working because it is up to date and relevant. Microsoft’s worked too well in the 1980s and 1990s and the company is now suffering from its largesse. Oh dear, how sad….
The guy who wrote that horrible, horrible article no longer works for them.
Great article. I used to wonder sometimes if this blog was really
written by SJ himself, so incisive are the insights. But we all know
that SJ doesn’t even read this blog. Right? Anyway, great analysis.
Great article Daniel.
This is the kind of stuff we all come for.
One question, was this article written pre-Elephant Man head?
I only ask because if you were able to write this article in the hours since your surgery, all drugged up with codeine; that wold be more than any other mortal could do.
Anyway, thanks for giving us such a tasty bone, so soon after scaring us all half to death; talking about you might not wake up and all.
Thanks again for a classically great piece.
Oh it is such a pleasure to know you are not alone in this world. Thanks for so eloquently expressing the damage done by MS to the advancement of computers. For years I have had to listen to people saying to me “oh, I can’t use computers” and I blame it all on microsoft and windows. However, Apple could have done better. It has taken the EeePC to bring in a simple interface with BIG buttons related to what you want to do. I so wish Apple would resurrect its own attempt (back in the early 90s on System
to provide a simple interface that even Gran and Granddad could use - especially now that these are true multimedia devices.
Thanks Daniel (and I hope the op went well)
Daniel,
I’m glad you survived your surgery and are back at it!!
I always enjoy your insight and analysis, but I differ with you on your belief that the Govt could provide health care…as mentioned in your other article.
When has the Govt provided a good product or service?
Why do you have such belief in the free market to provide computers and software, but not health care?
If the Govt failed to regulate Microsoft effectively, why should we believe they could tackle a more difficult problem like health care?
Witness the recent/current problems with energy, space shuttle, Katrina, Iraq, budget deficit, etc.
Pull vs. Push: Pull marketing and distribution techniques are far more appropriate to the consumer sector ’cause it educates and encourages the customer to make choices and take initiative, rather than blinding pushing product into channels—as does Microsoft. Push is 1900s, preweb, top down, oligarchic.
Gee I wish I could edit my comment for grammar.
The fundamentalist idea that government is good for nothing and free market is good for everything is certainly ubiquitous. Kind of like “Apple should license their OS.” Well accepted by many, but out of touch with reality.
The government has done great things in some areas. It should stay out of others.
Anyone who says healthcare is better off in a free market has never been sick. Or they make enough money they don’t have to deal with an HMO. Healthcare that cares more about stockholders returns are similar to the mortgage market. It just hasn’t crashed yet.
I lived in Canada for a while. I’ll take their healthcare system back then (conservatives have ruined it in the past few decades) over ours now any day.
ewelch,
If a person can’t afford health care now, how can they afford it when you add in 20-30% for Govt inefficiency?
If you don’t like paying for your own now, how will you like paying for your neighbors too in the future?
What are some examples of what Govt has done well and efficient?
Govt procurement has trouble buying a new tanker for the Air Force. You want to tackle nationwide health care? Who’s going to pay for that trillion dollar social experiment?
That was a jaw-dropping article.
I never get it when people rag on the Government. Sure, we’d all be
better off if corps like Enron just had their way, right? Yeah, right.
Or look at the housing boondoggle. That was the Government’s
doing, right? Actually they didn’t do enough to prevent it, is all.
Because when the Government gets behind an idea, they succeed.
Look at Medicare, Social Security, and the moon landing ideas.
If our Government ever really got behind alternate energy, then OPEC
would be out of business. It’s almost as though too many politicians
somehow benefit from oil corps. Nah, that couldn’t be true, right?
We should get all the stinking money out of politics, so things
could be done right. But I’m not holding my breath on that.
@Lee R.
“…If you don’t like paying for your own now, how will you like paying for your neighbors too in the future?”
We already pay for our neighbors health care. Most states have health care programs for indigents that we all pay into with our tax dollars. I agree with you that our government doesn’t have a good track record with doing anything particularly well and efficient - but that’s just it - our government. To fix this problem requires a much larger fix to the fundamental problems this government has.
Our government is bailing out banks left and right because they (the banks) authorized loans they never should have under the assumption that most of those people would be too afraid to get foreclosed on - well they were sure wrong. And now we are seeing these trashy banks and their political paramours working hand-in-hand to escape the consequences they should be facing.
If the health care industry were to go under - guess what… the government would be bailing them out too. Maybe instead of government supporting corrupt businesses, they should just focus on their population.
Ummm, how can the Conservative Party have “ruined” Canadian healthcare over the last few decades when it has not been in power over the last few decades?
Rather, you should look at external changes to the larger healthcare landscape that have made healthcare more expensive and (more sucky) regardless of who is paying for it?
Concerning government health care, let me give you an interesting example of what happens when government stays away: Lazik eye surgery, which as far as I know is not covered in any insurance plans.
Five years ago it was $1,000 an eye
A year or two after it was $500 an eye.
And now it’s $250 an eye.
Hospitals appear to be incentivized to increase costs, not reduce them. How much has a major operation increased in the last five years?
I think people should buy the health care they can afford to pay out of their own pockets. Then prices would crash to sanity. A bunch of hospitals would go bust, yes, because they have created ridiculous cost structures, but prices would go down.
When government pays for something, prices go in one direction: Up. That’s why Canadian health care was reasonable for a while and then shot up, and then the Conservatives had to reel it in.
The only way you can avoid bureaucratic rationing of your health care is to be able to pay for it yourself.
Having an operation in India costs 10% of what it does in the US. I would certainly go to India instead of paying today’s ridiculous prices.
I’d rather not see National Health care because it would force those ridiculous prices on me (albiet indirectly, through taxes) and there would be no way I could avoid the system.
D
The NeXT computer should be listed as a “software move” rather than hardware - NeXT is where the current OSX / Apple model came from. NeXT could not best the MS monopoly because it would never run MS Word but the Mac was grandfathered in, as it were. Able to at least run MS Word for enough time to build back its own market. That was an opportunity that only Apple had. Apple built new markets, music and video and subscription and so forth only because the computer could also run office during the decade of transition needed to move users away from closed desktop style software. Software that hasn’t changed much since the 80’s. In a few years, Web browsers will be able to edit documents online and internet collaboration will take on new meaning. There is no need for MS Word in a connected world. MS would have to actually invent something of use or interest and that’s just not very likely. I’m sure MS will be fine, but their days as the only game in town are over. Once developers moved off MS’s closed platforms and into opensource and internet tools, then the future was sealed. Google chrome leads the idea that the desktop
OS can no longer prevent progress which means MS will end its reign.
ewelch,
“If a person can’t afford health care now, how can they afford it when you add in 20-30% for Govt inefficiency?
If you don’t like paying for your own now, how will you like paying for your neighbors too in the future?
What are some examples of what Govt has done well and efficient?
Govt procurement has trouble buying a new tanker for the Air Force. You want to tackle nationwide health care? Who’s going to pay for that trillion dollar social experiment?”
This is a very ignorant statement. You obviously don’t understand how insurance works.
When you pay into any kind of insurance be it car, life, fire or medical when you make a claim you don’t get back the exact amount of money you paid into the policy, it’s possible you might get back 10 times or up to 1000 times the amount you paid in. The extra money you get comes from all the premiums all of the other policy holders are paying.
So when you buy health insurance, yes, you are paying for your neighbor’s health care as well as your own.
This is how all insurance works, socialized medical care and HMOs alike, and don’t forget the basic rule of all insurance is to deny claims as much as possible, thus maximizing profits. Why base a health care system on a rule of exclusion? Socialized medical systems are basically the same as insurance companies only they are run as non profit, so people don’t get excluded due to financial reasons. This puts an end to the private insurance industry’s practice of sentencing people to death simply to maximize profits.
Make people’s lives more important than profits, that’s all we’re asking for. If you don’t think your government can handle that then you need a new government, because most of the civilized countries in the world already have health care systems like this and they work real well. Why are you so satisfied with the incompetence of your USA government? Most other governments in the world manage to do this just fine. Saying your government is too incompetent to do something like this is the same a saying you yourself are too incompetent to do this, a government is just an extension of its citizens.
I really don’t want to pay for my neighbors’ health care. If Better they die than I have to give away those lovely money.
You guys, take the health care conversation to the comments of the relevant article, please.
Anyway, excellent article again, Dan. You surely do have a way of articulating exactly what’s going on in the backs of our minds in regards to Apple and the technology landscape.
I hope you get well as soon as you can.
Daniel, I’m really glad to see your next article so soon!
It is interesting to think back of the 1980’s. So long ago and still I do have vivid memories, I was a student by then (yes, I’m getting old). In 1984 we typed our reports on a typewriter. Five years later I had my own Atari ST for wordprocessing, calculation and games, which was a major improvement.
In the early 1980’s were in desperate need. Hardware was primitive, software was primitive, everything was expensive. Apple computer (either Apple II or Macintosh) were FAR beyond reach, so was IBM PC. If you were lucky you might be able to get a Commodore 64 or Sinclair Spectrum. But the worst thing was lack of standardisation. Not only the programs were different, the data was uninterchangable as well. Start a Word document on your computer and ask your mate to finish it on a different brand? Forget it.
A de facto standard was very much needed. In those days nobody thought IBM PC was a great computer, it sucked and it was absolutely obvious it sucked, from the first day on. But it amazingly provided exactly what was needed at that moment: an extensible hardware platform that allowed zillions of third party hardware developers to experiment with the components we take for granted today be we had no idea by then what was needed and what was not. And above all, software and data compatibility.
You can say it was sheer luck Bill Gates was at the right place at the right moment and it sure was. But I don’t think that without the experimentation and diversity (and chaos) that the IBM PC platform unintendedly made possible on one side and the standardisation on the other, computer industry would be where it is today.
When we talk about integration of hardware and software today we are in a completely different environment. There is a lot of experience with data interchangability. And above all there is this huge platform of standardisation: the internet.
We were thinking hardware back in the 1980’s, we return to thinking hardware now, in a completely different situation. I think this would make this in-between period when software was king only more impressive and interesting.
as a canadian, i’ll take our healthcare system over the american version any day of the week.
i would rather pay taxes that cover just about ANY operation, no questions asked, than have an insurance company tell me my wife or daughter doesn’t qualify for a life saving operation.
americans: don’t knock till you’ve tried it. capitalism doesn’t solve everything.
@gothgod: it called community.
dan: great article as always. get well soon.
@Berend
Excellent insight!
In quite an important way, the IBM PC (for all it’s ho hum inadequacy when it first came out) moved things along by becoming THE hardware and software standard, when so many of us were struggling with the exact incompatibility nightmares you described. I too started out on other platforms, only coming to the PC when clones finally made it affordable (Amstrad in my case!) and, sigh, Microsoft made sure all your documents worked everywhere. And I’m a few years younger than Daniel!
Sure, it would have been better for us all if it were the Mac which made it back then instead of that nasty PC. Gates himself tried to convince Sculley of the need for it. But what’s done is done. The computing landscape until 2000 was sealed.
The Internet has indeed become the great leveller since then. Hurrah! It alone enabled my own move to the Mac five years ago. Microsoft’s goose could well be cooked…
But will it be Apple?
I have my doubts. Apple hate to make crap. And so much of the market seems to like it! I can’t see Apple ever dominating this vast, commodity driven, field. But they’ll continue to make a killing, as well as the best computers in the world.
Good to have you back and safe, man, and great article.
And I think too that the new genius tool is working well even in countries, like mine, where there is no itunes store. I like genius a lot.
Politics a child can understand.
I remember the time that Kathryn, one of my daughter’s little friends,
told me that she wanted to be President one day. Both of her parents
are liberal Democrats and were standing there with us - and I asked
Kathryn, “If you were President what would be the first thing you
would do?”
Kathryn replied, “I would give houses to all the homeless
people.”
“Wow, what a worthy goal you have there, Kathryn.” I told her,
“You don’t have to wait until you are President to do that… you can come
over to my house and clean up all the dog poop in the back yard and I
will pay you $5.00. Then we can go over to the grocery store where
the homeless guy hangs out, and you can give him the $5.00 to use for
a new house.”
Kathryn, who was about 4, thought that over for a second while her mom
looked at me, and then she replied, “Why doesn’t the homeless guy
come over and clean up the dog poop and you can pay him the $5.00?”
Welcome to the Republican Party, Kathryn.
Wow. Five dollars for a house. That’s a very good deal.
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