Umair Haque / Bubblegeneration
umair haque  


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

Saturday, July 31, 2004

Another interesting comment on my Apple vs Real thread:

"...There is a big problem in comparing the iPod strategy to what happened in the PC world. While the PC economics are driven by demand side economies of scale (also known as network externalities or multiplier effect) where the demand is dependent on the number of users already using the system, the Music market does not have such effects."

OK. I'm going to take you beyond the simplistic view of network strategy you learn in Info Rules a little. Let's forget about 'demand-side economies of scale' - let's just say network externalities; that's the term economists use. We'll also assume the externalities are positive for the time being.

First, this isn't 1999 - so we've got to distinguish between direct and indirect network externalities. Direct externalities are strong; indirect ones are relatively weak. That's because indirect ones are mediated through a central mechanism, whereas direct ones are imposed on members of a network by other members. In fact, even Varian and Shapiro have talked about this as far back as the 80s.

Now, it's pretty clear that the network externalities in the PC industry in the 80s were indirect - they consisted of platform leverage increasing the gains to complementary assets (ie, more software being created). On the other hand, anyone who's ever used a file-sharing program will tell you that the network externalities are about as direct as you can get. A song is not a song is not a song - you've got to find it and listen to it first, which is costly. That's why digital music is direct network externalities - via playlists, MP3 blogs, collab filters, etc, etc. This is where Apple's got a chance to shape new industry structures and remedy the coming market failure.

So I think this argument defeats itself - if anything, the economics of the digital music industry in 2004 is like a hypereconomics of the PC industry in 1984, which suggests that there will be a winner-take-all market, and gains will flow in increasing returns to first movers - but only if they're platform leaders who create an infrastructure for direct network externalities. How can they do this? Radical innovation, which also exerts platform pressure.

Think again about 1984. Did Apple fail to even exploit the weak indirect network externalities of the industry economics, by locking up it's platform, thus failing to increase gains to complementary assets (ie software). Of course - that's why the PC vs Mac is a classic b-school case study. And that's the point. It's doing the same thing over again, right now - it's failing to exploit the direct network externalities offered by digital music as a target for radical innovation, which it can leverage to create a platform, grow the market, charge for access, and exert massive pressure over complementors, suppliers, and buyers. Locking up it's platform trades market power now for market power in the future - that's not a smart bet.

You can, as I've suggested numerous times in the past, read Stan Liebowitz to find out about network strategy beyond Info Rules. You can read my New Economics of Music piece (right) for even more. And if you're really interested in discussing network strategy, you can check out Economides work to understand what the theory behind it really means - just saying 'demand-side economies of scale' is what Tim Oren talks about when he slams Reed's Law (below).

Wow. I am really surprised that what I'm saying has generated so much heat - this is just basic digital strategy as practiced by countless firms; is this the Jobs Reality Distortion Field at work!!? (ducks)

Update: Now I get it. Referrer logs tell me there are a boatload of people showing up here from Macsurfer (which accounts for my inbox that's full of hate mail!). So I'm preaching to the unconvertible - I'll stop now. Apologies if you've never read bubblegen before and you're having a tough time following the technical bits of the arguments - it's not intended entirely for the layman.

Thanks to everyone for the comments.

-- umair // 1:23 PM // 7 comments


" Locking up it's platform trades market power now for market power in the future - that's not a smart bet."

You just won't listen, will you? Apple locks up its platforms because they think (1) integration yields a much better user experience and (2) innovation is faster when one company is in the drivers seat, as opposed to a 1000 different companies. This is in apple's DNA and that's why no matter what made sense from a "market power" standpoint, apple wasn't going to open up the mac.

Apple didn't open up the mac because they didn't think that would make a better product for ordinary users. Maybe it didn't make the best product for corporate users. That's fine. But apple's way is better for apple's customers. If you don't like apple's way, choose a different product.
// Anonymous Anonymous // 4:33 PM

Uhhh...I know I shouldn't waste my time, but...

1) Innovation is by *definition* faster with 1000 companies driving it. I take it you understand what competition and selection pressure mean.

2) Integration may yield a 'better user experience' - Apple's still free to offer an integrated solution *even* if it opens up a platform.

Of course, anyone's free to choose a different product. This has absolutely no bearing on a discussion of Apple's strategy.
// Anonymous Anonymous // 5:00 PM

You make some very great points. I hope Jobs has the opportunity to read economic theory such as that you present here. I am a big Mac fan and believe that Apple develops some very good products.

I hope you are wrong but am afraid that you are exactly right. That the iPod will become a sacrifice to the Gods of Redmond. Microsoft believes in the network effect. They never want to develop the best product, but are always concerned about CONTROLLING the underlying technology, beit OS, media format, internet browser, etc.

I wish that there were folks at Justice with enough balls to stand up to the largest monopoly of the modern era. If not for Microsoft's anti-competitive practices, Mac, Linux and Windows could peacefully coexist. Consumers (both corporate and personal buyers) would be able to make purchasing decisions based on perceived value - whether cost or better features, such as better integration and less crashing - instead of feeling obliged to purchase a product that may be inferior but compatible with X or Y product.

Openness is better for consumers whether in computers or in digital music players. But let's open up the computer front first. There's more at stake there.
Although, you may be right about the opportunity for Apple.

I wonder if there is a way to be able to own the platform, make it open, and still be able to develop a complete, integrated product - Apple-style. Palm was doing it for a while. But they are dealing with intense competive pressures in the handheld market from Microsoft and others. Sony, a Palm licensee is even getting out of handheld market in the US and Europe.

Could Apple continue to create and innovate killer iPods, iTunes and iTMS while at the same time allowing intense competition from everyone else on their own platform?

I believe that in time there likely will be one platform where anyone can buy any digital device and use it with any music store. People don't want to have incompatible music that they can't play with other services. but that's assuming others will be successful. It's a strong possibility.

Jobs is betting that he can continue to CONTROL the digital music space by maintaining high market-share AND continue to keep it closed. If market share should erode, I think they may be prepared to open up. Hopefully, at that point, it won't be too late. At this point, mant would love to join the Apple iPod music lovefest. Hopefully, they would still want to join the Fairplay party, if and when Apple's share starts to go down.

They still have some good arguments for others to choose AAC and Fairplay.
1) The technology is superb.
2) Microsoft won't CONTROL the technology.
3) Apple is commited to continual innovation in area

Real is desperately trying to crash Apple's iPod party. They already use AAC and they reverse engineered Fairplay so that they can put Rhapsody songs onto iPods. That's a good sign.

Anyway, I've been bringing a lot of other considerations to this discussion. It would be nice if everyone could get iPods and use iTunes at iTMS. But your network effect argument is sound and strong.

I can only hope that you're wrong, because I don't see Jobs changing direction any time soon. He's got a great product -- the best one -- and seems destined to exploit it maximal market potential without giving away any jewels to competitors. At least, it looks like it going to take it slowly. On the other hand, Apple did agree to produce iPods for HP and is licensing Fairplay to Motorola for cell phones. So it looks like he's going in the right direction, with the least sacrifice of his current cash cow -- namely iPod.

I think he wants to control the Music selling experience so he doesn't want to play with other online music stores, or anyone who owns an online music store or plays nice-nice with one. WMA is out of consideration, and even AAC from a competitor (Real w/ Rhapsody) is out because they are not using iTMS.

Apple may be protecting iTMS's long-term survival. It may not be producing much in terms of profits, but I'm convinced that Jobs beleives that one day more digital music will be sold than CD's; and that's the prize he wants. To own the store, not just control the the format for everyone else's stores.

What are your thoughts.? You seems to write intelligently on the topic.
// Anonymous Anonymous // 6:49 PM

There's another issue at play here too - the media player wars. Apple has been using iTunes and the iPod as a backdoor for the introduction of Quicktime onto PC's, and is doing so very successfully. Every copy of iTunes downloaded - even if the user runs it once, doesn't like it and reverts to WMP - is an install of Quicktime, and once that user has done so, no website he visits with QT content will ask them to download a plug-in - which they dismiss anyway, and move on. It becomes part of that users software world, and increases useability of QT content web-wide. It's a smart play, and by doing so, and by pushing back against Real, they are indicating they see Real's market space as the one one they have their eye on.
// Anonymous Anonymous // 8:10 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

Why should we pay attention to someone who doesn't know how to use the apostrophe?
// Anonymous Anonymous // 8:48 PM

Response to the dodo head who wrote the following:

"1) Innovation is by *definition* faster with 1000 companies driving it. I take it you understand what competition and selection pressure mean.

2) Integration may yield a 'better user experience' - Apple's still free to offer an integrated solution *even* if it opens up a platform.

Of course, anyone's free to choose a different product. This has absolutely no bearing on a discussion of Apple's strategy.

# // Anonymous // 5:00 PM"

(1) Oh yeah, then why did it take apple to jumpstart USB and firewire and wireless networking and home video editing and on and on and on and on. There's a fundamental problem with the open PC platform. If implementing anything new takes hardware and software (often the case), there's a severe chicken and egg problem: why should dell implement hardware for something that there's no software for? why should MS or application programmers write software when there's no hardware for it (or it's not widely adopted). See the problem?

As for competition and selective pressure, let's go back to basics for the brain dead of you here. Apple has closed platforms (mac and iTunes/iPod/iTMS). OK, now is there competition for these closed platforms. YES idiots. Does anyone think windows is not big time competition for the mac? The idea that closed platforms are not subject to competition is retarded and disproven by this one example.

(2) No, opening up the platform means the end of integration. If apple opens things up and licenses things so that other portable players and jukebox software works with iTunes/ITMS/iPod, then it has to work with all these other people to make sure things keep working. That slows down apple's ability to innovate. Again, if they make the hardware, the software, the whole enchilada, then they can adapt everything to implement new stuff. MS, Napster, Creative are stuck trying to innovate by committee (doesn't work).
// Anonymous Anonymous // 8:59 PM
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