Category: Theory

Theory.

The case for the iPad's future

The question of low end disruption should be a concern to any manager. It’s one of the most important sources of growth and has led to a vast amount of wealth creation.

Apple was an early low end disruptor by selling personal computers at a fraction of mini-computer prices. Toyota also offered “cheap” cars as an entrant in the market. Pixar made blockbusters for a lot less than live action studios. Google offers good enough office software without a license. Finally Microsoft built its whole business on low-end business software at knock-down prices.[1]

All these entrants made fortunes often at the expense of entrenched incumbents. Disruption grows the pie but also transfers a lot of value away from existing competitors.

So it should not be surprising that new products like the iPad should be scrutinized for their vulnerability to low end disruption. Brian Caufield asks the question if Apple has any future with the iPad given the potential for $99 tablets.

The question is indeed why not introduce an ultra-cheap tablet, for example from Amazon, which makes up for the low price with an innovative business model like selling content or user behavior data. After all, game consoles are sold this way. This is the classic razor/razor-blade business model.

The answer to why not is actually not simply that the economics don’t work. They might work some day even if they really don’t today.

The answer to why not is that the iPad is not good enough.

Continue reading “The case for the iPad's future”

Polymath

In a rare reflective moment Steve Jobs, after the launch of the iPad, mentioned Apple’s DNA. He said:

“Technology alone is not enough. It’s technology married with the liberal arts, married with the humanities, that yields the results that makes our hearts sing.

Nowhere is that more true than in these post-PC devices…that need to be even easier to use than a PC, that need to be even more intuitive than a PC; and where the software and the hardware and the applications need to intertwine in an even more seamless way than they do on a PC.

We think we are on the right track with this. We think we have the right architecture not just in silicon but in the organization to build these kinds of products.”

Steve Jobs’ legacy in product development has been clearly established and celebrated. What remains now is to determine his legacy in company development. If indeed Apple has the “right architecture in the organization” to serially build disruptive products. The collection of evidence begins today.

If Apple has indeed become Jobsian then it will have been a grand achievement. John Gruber is already convinced. He points out

Jobs’s greatest creation isn’t any Apple product. It is Apple itself.

If indeed he has built Apple sufficiently well to last then he has built an admirable process and not just a product. But this would not be a unique achievement. There have been other companies which preserved their founders’ cultural imprints, at least for significant periods beyond their departure. Consider that Disney, Ford and even HP and IBM remained successful for many years after the departure of their founders operating much the same way. They were infused with an indelible culture and preserved it for some time.

But a leader should aspire to do more. A leader should claim to have left a legacy not just on their company but on all companies.

Is it not more worthy to have changed civilization than the fortunes of a few?

I believe that Steve Jobs has actually sought just that. He put it as “making a ding in the universe.” This can be interpreted as developing products that “change everything”. But if the thing that Steve Jobs should be most proud of is the creation of Apple Inc. then how exactly could an Apple Inc. benefit the world?

This is where Jobs’ quote above strikes me as valuable. The lesson the world should take from Apple is that a company needs to become multi-dimensional. It needs to mix the core business with the disruptive innovation. It needs to combine the intellectual with the artistic. It needs to maintain within it the rational and the lunatic.

Apple’s violent success should serve as a powerful beacon that others should follow. Rather than copying its products other companies should copy Apple’s processes–its way of thinking. They should copy how Apple harbors the creative process and the technology processes under the same roof.

If they do heed this call then we should look forward to the the post-Jobs era as that time when large companies gained the ability to intertwine multiple core competencies. A time when humanism balanced corporatism. A time when we came to reconcile the rational and spiritual.

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This post has be re-published in The Harvard Business Review Blog as: Steve Jobs’s Ultimate Lesson for Companies – Horace Dediu – Harvard Business Review

HP's decade-long departure

HP’s sudden departure from a business model that has sustained the company since inception is symptomatic of the passing of an era. Yesterday HP announced that it would exit the PC and tablet computer business, focusing on higher-margin “strategic priorities of cloud, solutions and software with an emphasis on enterprise, commercial and government markets.” In other words, HP is fleeing upmarket, away from a core that it will abandon to device makers.

HP management conceded that the disruptive impact of the iPad forced their hand but that hand was already quite weak from a decade of over-serving the market. The last decade offered plenty of opportunities for incumbent PC companies to adjust to the realities of mobility. However only one computer maker made the transition.

Why is that?

Consider how HP and Apple faced the changes in the PC market almost exactly a decade ago.

  • On September 3, 2001, HP announced that they would acquire Compaq.
  • On October 23, 2001, Apple announced the iPod.

The rest, as they say, is history.

Continue reading “HP's decade-long departure”

The fate of mobile phone brands

The violence with which new platforms have displaced incumbent mobile vendor fortunes continues to surprise.

  • Nokia’s Symbian platform has gone from 47% share to 16% in three years
  • Microsoft’s phone platforms have gone from 12% to 1%
  • Other platforms have gone from 21% to zero
  • Although far less dramatic, RIM’s decline from 17% to 12%  is causing acute pain and anxiety

This while entrants have grown share in spectacular fashion:

  • Android from zero to 48% (A two year period)
  • iOS from 2% to 19%
  • Bada from zero to 4% (two quarters only)

 

The picture of platform share over time looks like this: Continue reading “The fate of mobile phone brands”

A new way to value Apple

Almost all valuation models for Apple assume it’s a hardware company. The modeling algorithm for hardware is simple:

  • For each year in near future
    • For each product line
      • Compute contribution
  • Determine company value by summing contributions and multiplying by a P/E ratio

The major difficulty is in predicting the growth of each product line. This is difficult because buyers can be fickle. Companies employs all sorts of tools in order to secure repeat customers but if switching costs are low, the company can crash in value. For this reason, analysts pick various ways to predict device  sales. Some choose to index each product on production (channel checks), demand (customer surveys,)  or even on a top-down share of total (market research on growth of whole market and assumptions of share).

Although simple and convenient, this model does not probably match the way Apple is managed. The company does not build hardware products to sell and forget. It builds platforms which are best seen as sources of recurring revenues. Users are incentivized to continue buying devices. iCloud, iTunes and other Apple properties are expressly designed to that goal–and they are not cheap to run. So, the company must see the world through a different set of lenses than the default model shown above.

To think about the business like they do, we need to put the data through a similar set of lenses. I began with a modest proposal last month to value each user as a source of recurring revenue. Now it’s time to expand on this method.

The following chart shows the recurring revenues per user by product and the current and possible future size of user bases.[2]

Revenues/yr/user are bars with the left axis and the User bases are various colored circles indexed with the right axis.

The assumptions that went into the data are as follows:

  1. Device life span is as per previous article linked above
  2. User base growth for 1 year is: Mac 20%, iPhone 80%, iTunes 10%, iPod 30%, iPad 100%
  3. User base growth for 2nd and 3rd years (recurring): Mac 20%, iPhone 50%, iTunes 10%, iPod 20%, iPad 80%.
  4. The Revenue per user is assumed constant

Note that the user base growth figures are lower than the product growth levels seen historically. Obviously, the model is highly sensitive to these growth assumptions so they need to be scrutinized and tested rigorously.

Nevertheless, as a straw-man proposal,  the recurring revenues for all these products[1] is shown in the following chart:

Once the income is estimated, we can take that value and assume a profit margin (net) and then multiply the earnings by a multiple. Using a 20% net margin and 12x P/E yields the following chart.

(I added an assumed level of cash in green.)

This model would imply that the company today could be valued at $208 billion on the basis of its installed base alone. That value would be about $323 billion in one year and $620 billion in three years. Dividing by the number of shares outstanding (935m this year increasing at 2% a year) yields a share price of $222, $339 and $629 by mid 2014.

These values can be considered “lower bounds” on valuation since they assume income from previously secured customers. The speculative part of investment would be based on what the future bases will look like (so, for example, if one believes these assumptions, the $629 figure could be considered a target to be discounted to today).

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Notes:

  1. Excludes Software, Peripherals, non-iOS devices, and any other service revenue.
  2. Compare this char to social media companies (MIT Technology Review)

The Frontiers of Platform Adoption

In the last two weeks we received two more data points which allow an update to the “race to a billion” platform growth trajectories. Android reached 130 million active users and iOS reached 200 million.

The updated picture looks like this:

Note again that this is a log scale graph. Every major horizontal gridline is an order of magnitude (10x) larger than the one below. It’s a busy graph. The linear version follows:

For the detail-minded, it makes for some interesting comparisons, but I want to create a more compelling visualization. One where each platform can be judged for potential and impact at a glance.

To that end I came up with something I call the platform “adoption frontier” view. Based loosely on the Pareto efficiency concept the chart is reduced to show the latest known figure of (users,time) and overlay concentric arcs centered on 10 million/10 years and radii of unit years (x-axis).

Note that the time axis is reversed from the chart above. This was to allow the best performers to be shown at the upper-right of the chart.

The way to read this is as follows:

  • Each platform is represented by a point which shows its currently known peak in users and time to reach that number of users.[1]
  • The arcs (frontiers) represent possible performance classes.
  • The lowest frontier spans “four years to reach 10 million” to “10 years to reach 200 million”. The highest frontier spans “<1 year to reach 10 million users” to “10 years to reach 1 billion users”. Each frontier can be read in a similar way.
  • The main assumption is that a platform can reach more users but it takes time. Better performance is when a platform moves toward a frontier further from the origin.[2]
  • I chose the limits of the chart specifically: 10 years is roughly the limit of most platforms[3] in the current cycle time of technology disruption; One billion users is an upper bound set by Windows.

One thing you can read from the chart is to say that “from a growth point of view, Blackberry is weaker than any of the other platforms.” Sitting below the lowest frontier with fewer users than Android which has been in the market for less than a third of the time it seems to be less impressive. It is, however, in a similar band of growth as Xbox 360, which, by some measures, is a success story. So the performance standard is relative.

One can also see the rough equivalence in growth between iPod and Symbian, both having crossed the second frontier. But iOS and Android are in a different league. They sit alone beyond the fourth frontier. The fifth frontier is the “billion user in a decade” potential and it seems within reach for both.

What this view also offers is an answer to the question of competitiveness. Although platforms can co-exist and don’t necessarily overlap, the question of becoming overwhelmed with “good enough” by widespread low end alternatives looms for the specialized platforms. For example, game consoles look very vulnerable because they simply do not have the potential to cross high frontiers and orders of magnitude of casual gamers (with potential TV connected devices) might orphan the consoles.

I’ve also included some platforms that have peaked and faded (AOL and i-Mode and Netscape) as a warning. The frontiers illustrate of how hard it is to reach the upper limits of growth. Each level is exponentially more difficult than the last and achieving it with paying customers is a remarkable story of value creation.

[UPDATE]

I add below the frontier chart with a linear vertical axis. Note that the frontier lines are not equivalent to the frontier arcs in terms of coverage.

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Note:

  1. The data I have is for platforms where users have to pay something to participate. I exclude platforms where users are the only merchandise being sold (i.e. social networks or email provision).
  2. I only include the initial ramps not upgrades. Windows is anomalous because it is so old. During its first decade (1985 to 1995) it reached over 17 million users but placing it on this chart does not do it justice given the growth occurred in its second decade.
  3. See Symbian and Windows Mobile. However again, Windows which is nearly 30 years old, is an exception.

 

The Android (in)adequacy: How to tell if a platform is good enough

About 10 years ago I met an advertising executive in New York who explained the difficulty of advertising a new brand of deodorant to consumers. “Most people never change their deodorant,” I remember him saying. “They pick one brand when they are young, and stick with it for a long, long time. If it works, why switch?”

The same theory can be applied to customers who are making the switch to smartphones today. Once they have picked a type of phone, whether it’s Apple iOS, Google Android or something else, it’s difficult, and often expensive, to switch. Consumers become comfortable with the interface and design of the phone and the apps they have purchased on that platform. If it works, why switch?

Many Smartphone Customers Are Still Up for Grabs – NYTimes.com

This quote says a lot. The notion that customers remain captive to a platform is well understood. After all, it seems impossible to get people to switch out of Windows (or Mac or iPod). Platform vendors are aware of this as the land grab for users seems to be running at full pitch.

However, there is a critical condition described in the quote above: “If it works, why switch?”  The condition which keeps users loyal is that the product they chose is good enough–i.e. “it works.” That’s a symptom of over-service and commoditization. If a product, like deodorant, is good enough you won’t be tempted to move to another brand even if it’s marginally better since the new brand has switching costs in the form of uncertainties (“Will it be as good? What if I don’t like the smell? etc.) People are inherently conservative and you can’t compete with comfort and familiarity by launching a marginally better product.

So with that in mind, why is it that millions are switching mobile platforms? Continue reading “The Android (in)adequacy: How to tell if a platform is good enough”

Is Nokia worth less than Skype?

Yesterday Nokia warned that its guidance for the quarter and the year were “no longer valid.” The surprise to me is that management was surprised. In February I warned that even if Nokia could fool consumers into buying products whose platform was publicly executed, distributors and operators would not likely go along with the deception. Pricing collapse is the proof of a channel breakdown.

That seemed predictable. What I struggled with was how Nokia itself could present such an optimistic forecast. Absent any explanation, Nokia’s forecast of robust sales for Symbian products into the near future belies a failure of understanding of the dynamics of platforms and especially the impact of destruction of trust and brand value that commenced in February. Distress is a slippery slope and it does not model well in a spreadsheet. It takes a leap of non-linear faith to predict the piling-on effect on the up- and the down-side.

Faith in the company’s guidance meant that the market reacted to the bad news by discounting Nokia down to a market cap of $26.7 billion. One analyst even cut his target price down to $4/share, 57% of yesterday’s close. How can this fair? What is Nokia’s phone business worth?

Continue reading “Is Nokia worth less than Skype?”

Is RIM's management the cause of its failure?

“Jim and Mike brought the company to where it is … which is part of the biggest problem they’re facing,” said Charter Equity analyst Ed Snyder, who has covered RIM since its public listing in 1997, two years before the BlackBerry was launched.

“They’re stuck in the past. They know what worked and keep playing that card and it’s not working any more, and they don’t seem to have any ideas,” he said.

via BAY STREET-As RIM struggles, talk of a change at top surfaces | Reuters.

In the case of Apple, the departure of the founder is considered a grave threat to the continuing success of the company.

In the case of RIM and Microsoft, the continued tenure of the founders is considered a grave threat to the success of the company.

Clearly, the theory that founders of successful companies can assure continuing success is flawed. Coupled to that implied causality is that departure of founders is always a problem.

Both are reflections of the idea that companies are predominantly successful (or fail) because of the skill (or incompetence) of a small group of individuals.

What the idea fails to explain is why companies fail (or succeed) as a cohort. RIM’s troubles are similar to Microsoft and to Nokia’s. Did they conspire or collude to fail simultaneously? Historically, incumbents fail simultaneously, regardless of who’s in charge.

And what about the problem that a company goes from success to failure (and vice-versa) while the same management is in charge. The “smart manager” theory of company success is as pervasive as the “stupid manager” theory of company failure. The perplexing thing is that while both of these theories are applied within the lifetime of a company, the management does not change.

Did Microsoft pay for the wrong Skype?

When a company is acquired, the price paid is usually higher than what the company is worth. This is because there is a “control premium” that needs to be paid so that the acquiring company can control the destiny of the acquired company (while the seller loses that right). So the question has to be what does the premium (or excess cost) buy? What is the value of that control? What will be the new destiny? Whose destiny is changed?

Clayton Christensen succinctly defined the value in any company as the sum of three constituent parts: resources, processes and business models. Market value can be nothing more and nothing less than these three things.

An acquisition has to be positioned on one of these targets just like a product is positioned on a specific market. The problem with being deliberate about where the value lies is that once positioned a certain way, the integration team will begin to execute on that plan. This means that the thing you decided was worth most (e.g. resources) gets all the attention and the other potential sources of value (processes or profit models) are discarded.

Continue reading “Did Microsoft pay for the wrong Skype?”