Umair Haque / Bubblegeneration
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Design principles for 21st century companies, markets, and economies. Foreword by Gary Hamel. Coming January 4th. Pre-order at Amazon.

Friday, July 30, 2004

Apple Vs Real

Ok, so you know by now that Apple's not happy that Real's 'hacked' iTunes + FairPlay to deliver Harmony files to iPods. What's the deal?

The deal is this: Apple is committing a massive strategic error. We know that iTunes as a distribution channel generates little revenue for Apple - it's iPod sales that are the cash cow. So why is it worried about Real? Apple's worried that Real's access to the iPod will limit it's ability to sign even more suppliers (labels) to iTunes - and as this happens less and less, Apple's ability to exert monopsony (aka a single buyer) power over them is broken.

That tells us pretty clearly that Apple's unspoken strategy was to leverage iTunes into the distribution channel for digital audio, and, eventually, when the market grew and their monopsony position solidified, flip the onerous terms of the licensing and royalty agreements demanded by the labels around.

Now, I've argued time and time again that iTunes is not the kind of radical innovation that is going to disrupt the media industry - it's the same old business model with a nose job. This is a great example. Apple's goal, now threatened by Real, is not to disrupt or even to change industry structures, but simply to maximize it's position - to become a monosponist.

That's not a smart strategy. Here's why: the huge wealth that Apple's created (Jupiter estimates iPod penetration at 5% of US households) is because it's created the first viable platform for portable digital audio. As in any platform, the value resides in the interfaces between the platform components. We've already answered the million dollar question - Apple doesn't open the interfaces because it hopes to become a monopsonist.

But Apple's defending it's monopsony position will necessarily be incredibly costly. And this is where the error lies. First, coordination costs are falling for every standard and platform. We see new digital media standards bubbling up almost every month. What this really means is that switching costs are always and everywhere falling faster and faster for new standards. This makes it increasingly likely that customers will, at some point, defect to a superior standard. Second, it will face attacks from reverse-engineering competitors (like Real), from it's user base (as it's licensing terms become increasingly onerous), and - here's the kicker - from the media industry itself.

Do you think the media industry will accept a monopsonist when alternative standards are knocking at their door and switching costs for customers are low? I don't. Apple's much better off opening it's platform up, expanding the pie for everyone, and appropriating smaller slices of value from many more players - and, crucially, spreading out the considerable standard, platform, market, and regulatory risk it currently faces. That's the opportunity cost of the monopsony strategy - it can't do both.

You may also wanna see the posts above (and this one), which talk about Apple VS IBM redux, and the potential benefits of a platform strategy for Apple.

-- umair // 1:02 AM // 10 comments


Great article - pity I have no idea what a "monopsony" is...
// Anonymous Anonymous // 5:23 AM

Ever used Google?
// Anonymous Anonymous // 5:46 AM

Actually simple fatc is that what Real have done is illegal...they have tried to get around Apples DRM technology that they use on the iTunes Music Store. This is part of Apple's agreement with Record Companies that puts them at ease.
As far as American law goes...i think that circumventing DRM of copyrighted material (includes DVDs also) is a violation of the DCMA.
It maybe a risky gamble by Real who have realised that their Music store is a failure.
// Anonymous Anonymous // 8:55 AM

It's not 'illegal' until Apple proves it...that's why this strategy is going to be hard to defend.
// Blogger umair // 10:10 AM

This comment has been removed by a blog administrator.
// Anonymous Anonymous // 1:03 PM

The reason Apple doesn't open up the iPod to Real or others is simply that they think they can make a better product that way. And of course they are right, at least for now. It's widely recognized that one of the key reasons why Apple is ahead and offers a better overall product is that iTunes, iPod and iTMS all work flawlessly together. And new stuff is being added, like Airport Express, that works flawlessly. It's delusion to think that a million different players, services and jukebox software is going to work together as well as Apple's solution. That may be an unfortunate thing, but it's just reality so stop ignoring it.
// Anonymous Anonymous // 3:21 PM

From one perspective and applying the old ANALOG rules towards media - Apple's AAC M4P's are "locked" but unlike analog, you can convert that file to 4 DIFFERENT lossless format with a few clicks of the mouse and keyboard (CD Audio, AIFF, WAV & Apple Loss-less).

(and yes, AIFF & WAV are really just computer readable versions of CD-audio but it's still requires a reader/player that can decode that format)

So, the reality is that it's only LOCKED if YOU don't want to unlock it. At any point, if Apple stops selling AAC files, you can convert it a CD that will play on BILLIONS of devices worldwide!

And that goes exactly the same for REAL's current files. There is ZERO need to hack Apple's and your own files. Buy tracks at REAL - burn them to a CD - convert them loss-less to AIFF, WAV or Apple loss-less to load onto your ipod. Or if don't mind losing a little fidelity - Mp3 or M4P.

Then why is "Harmony" really doing except creating 'disharmony' and doubt?

Basically, Apple has set valet parking in their mall. As a consumer, there are advantages and disadavantages to valet parking as with buying tracks from the itunes music store but like valet parking, if convenience over-rides your other decisions, then convenience it is.

Real has decided that to set a competing valet service within Apple's parking lot - in the real world, it would be a quick settlement on property rights and right-of-way ... in the digital world, because people are less likely to see the larger picture, it's easier for Real to cloud the issue. In the valet parking situation, if Real tries to set up on someone else's property and cries restraint of trade - that would be easy to dispute.
// Anonymous Anonymous // 8:20 PM

You'd think someone that can use 50-cent words like "monopsonist" would know how to use "its" instead of "it's".
// Anonymous Anonymous // 8:44 PM

Real isn't removing DRM or allowing users to steal music - they're converting one form of DRM to another while maintaining the protection. It doesn't convert Apple's DRM to something else - it converts their own DRM to one compatible with Apple's so you can play their music on an iPod. Real is giving us a choice of what music we can play on our iPods.
// Blogger Mike // 11:51 PM

Anonymous: "You'd think someone that can use 50-cent words like "monopsonist" would know how to use "its" instead of "it's"."

Monopsonist is an term any good economist should know. Its distinction over monopoly is that monopoly means "single seller", while monopsonist means "single buyer". 'Its' and 'it's' is a distinction not required to be known in order to get that nifty Bachelors in Economics....
// Blogger Rajan // 5:41 PM

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