Apple is still screwing it up

To my eyes, this is looking like a repeat of the Macintosh-PC Wars of the 1990s which Apple lost. On the one side, you have Apple, competing at the high end and very concerned about platform integrity and control, and preventing other manufacturers from building its hardware. On the other side, you have another operating system designed for the lower end and installed on a host of manufacturer systems – which may or may not cause serious platform integrity problems down the line.  Who wins that battle?

In the 1990s it was Intel and Microsoft. And they went on to reap massive rewards as Apple foundered.  Today, Apple risks a repeat of this if it does not come out with a credible solution to deal with its burgeoning Android problem.

–Apple: Can it stop the Android menace?, Nov 2009

According to Gartner estimates, today, we see Android at 25.5% market share instead of 3.5% at this time a year ago when I wrote the intro snippet. Apple is at a still respectable 16.7%, down only slightly from 17.1% last year.  The biggest losers were Nokia and Microsoft. Here is a chart of the figures from Tech Crunch.

I won’t say I told you so, because it is still early days. But clearly Apple is still screwing it up. The problem: distribution.

Let me go at this from a side angle. Last month, I was at a friend’s house and his wife was raving about the Nook, Barnes & Noble’s open-source e-reader. She made a lot of good points that resonated with me, especially the part about Amazon’s Kindle format being proprietary. My wife was even more sold based on the looks and readability of the thing. Eventually, we’ll probably get one.  But I had my doubts. See, I am an early adopter who has invested in obsolete technology enough times to be wary of the new, new thing. Remember the wireless internet service provider Richochet?  I was on that.  How about Sony’s MiniDisc players? I was on that too. In fact, I’ve seen a lot of format wars – like Mac vs. Wintel, Betamax vs. VHS, or Blu-Ray vs HD-DVD – and have learned to sidestep these things pretty well now. In a lot of these cases, the losing technology was pretty cool. I loved my Richochet and MiniDisc a lot more than dial-up or a Walkman. But the defining element in each of these format wars has been distribution, not marketing, functionality, or coolness. The company with the most robust distribution channels won – end of story.

The first time, I encountered the ‘distribution’ problem was in 1995 when I was forced to switch from Mac to PC after having used the Mac for the past decade. What was clear to me in making the switch was that Windows blew. Buggy software like Quattro Pro, blue screens of death and troubleshooting an infinite list of incompatible drivers made this clear from the word go. But the reality was that the clones like Compaq, Packard Bell and Dell were flooding the globe with product – cheap product, I might add. They were in every CompUSA, Circuit City, MediaMarkt, Saturn, or Dabs you could visit. I went to them all. Distribution trumps functionality. It trumps coolness.

So when I witnessed the Android problem last year, I knew Apple needed a strategy to respond because it looked like the clone wars all over again (and I am not talking about Star Wars). Google gets this.  They are the IBM of the mobile space, while your Samsungs and Motorolas and HTCs are the Dells, Gateways, and HPs of that space.  What makes the Android story even more compelling is the fact that Google has realized it doesn’t really understand hardware and the important customer service  role that goes with it. They have gladly allowed the Nexus One to fade and let the Android Clones saturate the smartphone market.

Where’s Apple in all of this? Well, they are making some pretty good moves with the iPad and Ping. I like the integration with the Mac and Apple TV. They are doing a great job moving to an integrated cloud-based platform which allows users to use multiple form factors in multiple locations, with access to all the same information and the amazing Apple user experience. I applaud this. But clearly, Apple doesn’t get it even though the noise coming from the statistics is deafening. It’s the distribution.

I am being a bit harsh here because I suspect Apple does get it. What else explains Steve Jobs’ Epic 5-Minute Anti-Google Rant during the last quarterly conference call? Apple sees Google as a threat and is looking to make its case in word as well as deed.  The problem with Jobs’ argument about fragmentation is that it is the same one you could have levelled against Microsoft and the Wintel duopoly during the transition from the shambolic Windows 3.1 to Windows 95 and 98, Millennium, 2000, and NT to the integrated Windows XT platform. Microsoft didn’t get it right for years. And they still won because of distribution.

Now, let’s be clear. The iPhone is still the phone to beat in the smartphone space with the 4G model – irrespective of some of the signal problems. The iPad is still the tablet to beat. I don’t care how much hype you hear about the Samsung Galaxy Tab. It doesn’t measure up. But all of that is as irrelevant as it was in the Betamax – VHS format war and the Minidisc – MP3 Player war. Distribution is what matters. And the easiest, the best way to get distribution is to allow any and all comers to make your product. Apple is not doing that.  Will the end of the AT&T-Apple tie up help? Sure. But it doesn’t get you around the fact that Apple is one company competing against dozens all of whom are very likely to use Android as their preferred platform.

Here’s how I see it shaping up.  Android continues to make huge inroads and developers start focusing more energy on that platform. Either Apple’s market share erodes or eventually they are forced to compete at a lower price point. None of this is a problem near-term as the growth rate is still high. But when growth in the cloud- and mobile-related computing revolution slows, Apple will be exposed.

As Chris Wood pointed out in June:

In all honesty, not only does Apple’s iPad appear overvalued, the whole company does. Assuming the most aggressive growth model, based on a discounted cash flow analysis we figure Apple would be fairly valued today at about $190.00 per share, about 28% below where it now finds itself.

That being the case, you might be tempted to think we’ve found a prime short candidate. Easy money.

Alas, though we love easy money as much as the next guy or gal, we have to say that we would never risk shorting Apple. At least not until Steve Jobs has moved on. This is a special company. The level to which it’s been bid has little to do with the value of the iPad nor the present value of discounted future cash flows. It’s all about the brand.

No two ways about it, people just love them Apples. And as long as that’s the case, the stock is going to trade at a significant premium in the market.

Update 11/11/10:   I am not focused exclusively on the US. When I talk about distribution, I am not just talking about AT&T exclusivity. I am primarily referring to the distribution that is inherent in having multiple hardware manufacturers of your product with their own legacy distribution channels.

In regards to the AT&T issue, Jobs made the right choice at the time and has profited from this. The rev share they got was stellar. He could not have anticipated how quickly Android would have become a competitor. I credit Google here and do not fault Apple. The link-up with Verizon in the US is a big deal and will see Apple making gains.  Apple has been able to get a good revenue share from the reports I have heard. So over the near term, Apple should do quite well.

My concern here is not the profitability of the Android clones or even Google’s Android profitability. What I am concerned about is margin erosion at Apple going forward. Look back at the Packard Bells and Gateways of the PC Wars and you can see that they were not profitable. Microsoft was profitable because they rode the platform and a monopoly to prominence. Google is clever here in looking to monetize Android through search, and music and other services and let the clones take on the distribution.

One thing I should point out in Apple’s defense regarding the ‘Apple vs. an Army of Android clones’ meme is that Apple has seen this through in the past with the iPod when it bested all of the other MP3 manufacturers. The key here was the iPod-iTunes tie. Can Apple do this again with the iPhone? Maybe. Ping is certainly a good attempt to move in this direction. So despite what you hear negatively about Ping in some spaces, strategically it makes sense.

Counter arguments appreciated.