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 (2)

Taking some flak from Macfanatics about my Apple vs Real post. Look, I have an iPod. I like Apple. I think they've got a golden opportunity to shape the media industry of the future - and instead of doing something cool, they're blowing it.

First, a definition of monopsony. OK. I've argued that Apple's intent is downstream monopsony. It's equally possible that's Apple's worried about low-cost iTunes compatible substitutes for the iPod, although I think that's unlikely (since I don't think iPod sales are driven entirely by iTunes).

Either way, I think this will go down in history as one of Apple's biggest strategic errors. It's almost exactly like the PC vs Apple all over again. Apple faced the same choice then as they do now: open the platform, grow the market, and appropriate smaller bits of value from a vastly larger number of players, or keep the platform closed, and appropriate all the value themselves. They made the wrong decision then; they're making the wrong decision now.

At the same time, IBM made the wrong decision too - it captured almost no long term value from the massive wealth it created by coming up with the PC. So there's always a tension between opening and closing a platform. That much is obvious.

The trick that radical innovators grasp is to see beyond this simple dichotomy. They leverage their platforms to disrupt industry economic structures, and by doing so, they lock out competitors and manage to exert the power of a platform leader. Who's done this? Well, the most straightforward example is Intel. Intel's never been particularly worried about opening or closing it's standard - it leapfrogs chip generations instead. That's how it, along with MS, controls the rest of the value ecosystem. It leverages it's position in the platform by radical innovation to quality (in this case, Moore's Law).

How can Apple do this? It's pretty straightforward: leverage iTunes and the iPod. Use them to extend and build the platform via further radical innovation to platform cost, quality, network size, etc. Charge rents for access to the platform. That way, suppliers (record labels) are still locked in - only this time, the lock-in is implicit. Complementors (platform partners) are locked in - the pace of innovation (and control over new interfaces) locks them in. This is just a different way of cospecializing assets - except in this case, Apple's gains to cospecialization are greater than they would be under either a fully closed (or fully open) platform. That's because the pie is bigger than in the first case, and unlike the second case, Apple gets to wield the knife that cuts it.

In fact, Apple's monopsony strategy will have the opposite effect: it will almost certainly stifle radical innovation. How many monopsonists have an incentive to innovate? It's almost an admission from Apple that it can't replicate the radical innovation of the iPod again and again - or that it doesn't have the heart to. That's like cashing in all your chips now, instead of investing the wealth created by the iPod by to realize further gains in the future. That's exactly what Apple did before - when it faced the PC. Maybe it's a Jobs thing.

I'll end by saying forget about the DMCA - you cannot build a strategy around the DMCA. Why not? Because a strategy is about long term wealth-creation, not short term wealth protection. Let me put it another way: the opportunity cost of DMCA-style protection tactics is wealth creation - instead of creating new wealth, you're protecting old wealth. This should be pretty obvious to everyone by now. Think about Disney- while they were busy protecting Mickey Mouse, Pixar recreated the entire industry in it's own image. Pixar was thinking strategically; Disney was thinking protectively.

This is the one place I fault Siva's argument - consultants do know this, because numerous economists and business academics have shown that IP is not an effective barrier to competition. It's not the consultants who are at fault (this time) - my money is on the marketing droids at Apple and the record labels.

-- umair // 12:35 PM // 16 comments


You say that opening up iTune/iPod/iTMS will allow "further radical innovation to platform cost, quality," and that not opening up will stifle innovation because "monopsonists" don't have to compete.

Try thinking straight. For starters, apple's platform is closed but look at all the competition. Everyone is nipping at Apple's heels. Apple HAS TO KEEP INNOVATING
// Anonymous Anonymous // 3:42 PM

You say that opening up iTune/iPod/iTMS will allow "further radical innovation to platform cost, quality," and that not opening up will stifle innovation because "monopsonists" don't have to compete.

Try thinking straight. For starters, apple's platform is closed but look at all the competition. Everyone is nipping at Apple's heels. Apple HAS TO KEEP INNOVATING to stay ahead. How do they stay ahead. By keeping everything closed they make a better product.

As for the mac, it's always been better because integrated is better, with faster innovation, then trying to coordinate things from 1000s of different makers of hardware and software. Windows won because it was cheaper, and businesses viewed Apple as a toy.

iPod/iTunes/iTMS is different because Apple's solutions are not much more money (if any) and Apple has a good reputation for digital media among consumers.
// Anonymous Anonymous // 3:45 PM

uhhh..nobodys "nipping at Apple's heels". iTunes and iPod are the market leaders by far.
// Anonymous Anonymous // 3:54 PM

This is about DRM and ease of use as much as it is about playability. There is already a way to play .WMA and Real songs on the iPod. Remove the DRM and rip to .mp3. It's not as easy as Harmony, but it works and it doesn't break anything.

Real has a found a way to allow the iPod to recognize its DRM; Apple's DRM is consistent (up to 5 computers, burn playlists, keep forever, &c) Real's isn't: it varies from song to song. Allowing songs with REAL's drm restrictions to comingle with Apple's adds inconsistency and complexity to just playing your music on the iPod. When a REAL song can't be played anymore they're going to blame Apple... That's what Apple's trying to avoid because one of the selling features of their product is the ease of use that comes with consistency. With the iPod and iTunes you don't have to think about the terms attached to each song -- the rights scheme is fairly simple.

I wonder if Apple would have licenced Fairplay to Real as they did to Motorola if Real had agreed to use the same DRM terms that Apple did.
// Anonymous Anonymous // 4:14 PM

Nobody "nipping at Apple's heels"? What are you talking about? Sure, Apple is ahead now. But if anyone else catches up, then apple loses dominance. So they have ample reasons to keep innovating.

Anyways, innovation is in Apple's blood. Who seriously thinks they are going to stop pushing the envelope?
// Anonymous Anonymous // 4:46 PM

Umair, you're wrong!

Apple's strategy is to provide value in the quality of the user's music experience. This includes ease-of-use, aesthetics, etc. This quality also comes from the integration of the iPod platform - the iPod player, the iTunes jukebox, and the iTMS (for digital music) and iTunes ripping (for CDs).

Apple believes Real's music store does not enhance the iPod music experience, but detracts from it. First, Real's music store offers very little that Apple's doesn't. Renting music is the big thing but that doesn't work on portable players yet! 192k bitrate - how many can hear the difference? Second, to ensure the user experience, Apple will need to support Real's songs - if there are problems with the iPod, they will call Apple not Real. When Apple innovates and needs to change the guts of the iPod, they will need to coordinate with Real so as not to break Real's songs. That will detract from Apple's ability to innovate and waste resources. And Real's songs may or may not work; no guarantees from Real either!

You say Apple needs to "leverage iTunes and the iPod. Use them to extend and build the platform via further radical innovation to platform cost, quality, network size, etc." Well, let's see, there's the iPod mini. Then there is Airport Express. Then the iPod car kit with BMW and coming soon with Alpine and others. Then there is iTunes mobile music with Motorola and maybe others. How have the other music-competitors innovated? They have yet to even get the player, jukebox, store, and DRM right. Sucky players (except for battery life). Sucky stores. Sucky jukeboxes. Sucky DRM rules. Even Sony can't get it right!

All of Apple's innovations since the iPod expand the user's high-quality experience, and Apple saw no problem with revealing stuff to each of their partners. They are not even "charging rent" to these others yet (as far as we know). Why? Because they brought something useful to Apple in exchange. But not Real! Apple is still growing the pie, and Real doesn't help because only a few care about moving songs from player to player, and only a few care about renting music.

So yes, Apple is protecting. It is protecting its iPod users from songs that may or may not work. It is protecting itself from being hamstrung in its future innovation. It is protecting its award-winning intellectual property from people who offer nothing in return. It is protecting its future for the benefit of its customers. Those are things worth protecting.

A time will come when Apple will license technology to others. It has done it in the past with ADB, Appletalk, Firewire, Rendezvous/Opentalk, etc because networking interfaces benefits by being open from the beginning. (But not all interfaces benefit from being open; if it messes up the customer experience, then forget it!) It will license when other parties can bring something to the table that will improve the customer experience and will improve Apple's ability to innovate for its loyal customers.

Reconsider your view! You're at the wrong part of the curve!
// Anonymous Anonymous // 6:42 PM

As a former (and frankly, disgruntled) Microsoft employee, I have to disagree with your contention that Microsoft has any intention of 'radically innovating to quality'.

Microsoft's core intentions and business practices revolve around maximizing profit through lock-in of corporate IT buyers. No radical innovation is required to gain such a lock, since Microsoft enjoys monopoly status within this market group.

In such an atmosphere, radical innovation is discouraged unless it serves the career goals of corporate IT managers. Why ? Innovations happen outside their areas of competency, and thus reduces them to the level of everyone else: an explorer in a new world, possessing incomplete maps of the terrain.

Apple is a company that was founded with the corporate mission to put a dent in the universe (and which has now returned to that mission). The Open Source community is the soul of radical innovation, and they, too are changing the world.

In contrast, Microsoft does only that which it needs to do to maintain a lock on the juiciest revenue streams. While there are true innovators within the company, the soul of the company is as disconnected from "radical innovation" as that of IBM during the early '80s.

As history proves, and you yourself suggest, individuals and companies that fail to recognize true innovation are likely to have their fates decided by others.
// Blogger Will // 6:54 PM

Hi Will,

I absolutely agree with you - MS does not at all radically innovate to quality. That was bad phrasing on my part; I meant that MS and Intel are the platform leaders, and Intel is the radical innovator. The point was that Apple should strive to be a platform leader via radical innovation, like Intel.
// Blogger umair // 7:05 PM

First, why am I a Macfanatic because I disagree with your point of view?

It is impossible to say that a prediction is incorrect but you can give strong indications that it may not come true by looking at recient history. They history you are looking at is the PC industry. The history I'm looking at is the iPod/iTunes.

When ITMS first opened it's mac only doors the industry stated that it would flop and others like BuyMusic would destroy it...oops! When the iPod came out people argued that much like the mac it was cool but over priced and would never amount to much in the industry....oops!

Now people (like you) are saying that Apple can't go it alone and needs to open it's DRM or die but history (short as it is) shows that ITMS is growing and so is the iPod....oops!

And people have tried to make the case that because Apple has not licensed FairPlay to anyone who asked that it will be a closed dead format but wait! They are licensing it to Motolora....oops!

And your hollow words about apple doing this because they don't want to inovate???? Have you seen the progression of the iPod? They have stayed ahead and need to continue to regardless of this "lock in".

Online music sales may some day be a huge money business and fair play licenses will probably become a nice ongoing revenu stream if Apple can continue to dominate this area. Why, you don't see this is beyond me.

The war is not over but Apple needs to get well entrenched while they have this huge upperhand. I see no reason to believe they will not grant further fairplay licenses in the future to continue to strengthen their position but they will pick and choose partners who grow their dominance for now.

The cost of inovation is very high and this lock in type of behaivor allows Apple time to benefit financially from this investment. Copywrites may have gotten out of hand and the DMCA may be over the top in some areas but both should be used to reward inovators by allowing them to profit from their investment.

At least that is this fanatics opinion!
// Anonymous Anonymous // 9:06 PM

I don't know why people keep going back to that Apple vs PC war that Apple lost supposedly because they didn't licence the Mac OS to x86 vendors. (Aside from the one time they asked Apple about it, Microsoft would have never let that happened and that was possible with all the illegal restrictive contracts it had with computer makers). The computer market has/had really no equivalent and we won't see history repeating in the same way in other markets.

The iPod plays MP3, AIFF, AAC (the no DRM version) and these are the format used by most iPod users because they either rip their own CD collection and/or use their MP3 files found on p2p. The Mac cannot run Windows or x86 apps directly (unless one uses somewhat slow emulator), and the same can be said about running OS X apps on Windows. That's a big difference here. The iPod not only runs on both platforms, but is also used mainly with non DRM open formats.

Not to say that DRMed AAC is irrelevent, because it's not, in the long term. But I don't see Record labels selling only online DRM music anytime soon, if ever.

My impression is that the more Apple keeps Fairplay to itself, the more companies want it. If Apple did all this in a very opened way from the begining, giving licences to everyone to make DRMed AAC playable on many players, and giving companies ways to do AAC based online music stores, there wouldn't have been that much demand for it and the iPod/iTMS market would have been fragmented and Apple wouldn't have been able to claim numbers like 70% of online music sales and 50% of the hd music player market. AAC/Fairplay based stores and players would have becomed minor players against the WMA tidle wave, with some failling to deliver a good experience.

Anyone heard of an AAC/Fairplay music store closing it's doors? no because there is only one and it's the market leader. For example if Apple had licenced AAC/Fairplay from the begining to 10 other stores and 3 of them failed and then switched to WMA or closed their door, these news would have discouraged any vendors from adopting AAC/Fairplay, and this would have had a spiraling effect leading to a complete failure of the format.

The whole thing would have likely crumbled and WMA would have becomed the standard, with no support whatsoever on anything other than Windows.

Would -that- be better for consumers?

Maybe some would say "but now Apple as a strong enough market share to avoid these problems". Did it have it six months ago? maybe 1 or 2 years ago? Where do you draw the line? If six months ago was too soon then how is it hard to believe that Apple feels it's too soon now?

And another thing, preaching openness is one thing but cautioning the unethical ways of Real is another. Weither Apple was right or wrong to refuse to give a licence to Real, which was using bullying tactics at that time in April ("licence us or will go see MS"), is pretty much irrelevent in this story. Real used unethical and possibly illegal means to get into the commercial part of the iPod, against Apple's will. If Real think they don't need Apple's permission, then why did they ask? Funny on how Real tries to portrait itself as a liberator, when the company is known to completely lock the -free- content to their media platform. You cannot convert Real media files to any other fomat, contrast that with Quicktime which can act as a converter between hundreds of video and audio standards, the only restrictions being on bought audio content.

Oh and please, iTunes is not the iTunes Music Store, the first is a software music player and the former an online store.
// Anonymous Anonymous // 9:43 PM

You know you've got a problem when you have Paul Thurrott agreeing with you.

This isn't about Apple losing grip on the wealth that Harmony brings. Harmony will increase demand slightly, but not by much. Real's store is a flop and people who like the iPod are planning on getting one. Apple has the best music store out there, hands down.

So what's the point? Obviously Apple has developed the iPod, patented what it could, expecting boring ugly ripoffs from the PC industry (thanks Dell, Creative, Sony, for showing how important you are to innovation in the industry). It marketed the iPod brilliantly and its only problem now is making the damn things fast enough.

So it is developping a veritable platform.

What's the problem?

If it wanted Real in on the party, it would have licensed Fairplay. Just like having tons of PC's for Windows to work on... the iPod would be shit if I worked with every store.

But, "Doesn't Apple want to be rich like Microsoft?" ... well, as it is now, like I said, DEMAND ISN'T APPLE'S PROBLEM. Supply is.

Partnering with a Software maker who makes crappy software and dilutes the iPod experience and hitches a ride on the iPod brand with it's clunky store would be dangerous venture.

Only in this case, there's no visible iPod revenue surge (supply is small).

And, oh yeah, Real isn't paying for the very thing they wanted Apple to work with them on a few months ago.

With iPod Updates, Apple has real by the balls.

In very much the same way that you can't build a defacto standard IM client by tapping into other IM clients' networks, you can't build a real defacto standard by telling your customers it's gonna be okay when YOU DON'T HAVE ANY CONTROL OVER THE TECHNOLOGY.

The Technology is Harmony. But Apple can tweak the iPod Software. (Is Real going to Advise iPod owners to steer clear of iPod Software Updates? I love it.)

Some people forget... Windows is causing people grief everyday because Microsoft had to be the standard, with its open architecture.

The iPod would NOT be so nice if it had an open architecture...

Ahem... We're talking about Consumer Electronics here.
// Blogger Mike // 9:46 PM

It's just that REAL has no credibility - here's a company that is built upon locking away content to its proprietary format - I think WE ALL need to ask Real for the real consumer's choice - where is our Real/RM/RAM to Mp3 converter or even to AAC?

That's the main problem - they are not unlocking anything of theirs instead, they are just intent on unlocking someone elses.

The people have spoken and made a choice already, haven't they? 100 Million+ tracks from itunes, how many from Harmony?

Their argument is like a someone selling a knockoff by saying, "people want something cheaper," well sure - but what about the sweat equity to build the original?

They just want to ride in after all the hard work's been done so they can make a couple bucks but perhaps wrecks the whole thing - the beauty of the itunes music store is its simplicity - it's designed FOR US. But because Real cannot conceive anything as useful, they would rather mess up the works for EVERYONE and cause confusion.
// Anonymous Anonymous // 12:32 AM


You claim Apple is missing an opportunity.

But the market is still nascent, pre-nascent.

Every other attempt by the competition, even with the aid of Apple as a model, simply sucks.

Why should Apple open itself to that? What percentage of the potential market owns iPods? .01% What percentage of the potential market purchases music on the internet? .000001%

Everyone is incorrectly assuming that Apple will further close the platform -- despite huge evidence to the contrary: deal with HP, deal with Moto, deal with BMW, deal with Alpine, deal with Roku over DAAP. Please explain what is going to happen over the near term (6 months to 3 years) to severely jeopardize Apple's position. Until then, the claim that Apple is shooting themselves in the foot (while being hugely successful and leagues ahead of the competition, I might add) just doesn't make sense.
// Anonymous Anonymous // 1:14 AM

Stepping back a bit for some perspective:

1. Will Real allow any third party to sell or give away software that will play Real media files? Or for others to sell software that will create Real media files and/or serve them over the web? No way. Real makes it's money by controlling it's own media formats, yet has decided that Apple will not control their own formats. Total hypocrisy by Real.

2. Where's the next Tim Berners-Lee? All this fussing and fighting over formats makes me appreciate how great HTML is, and what a miracle it is that the web exists. He has been quoted as saying that without what he did there would be many separate webs that would require different kinds of readers. Just like what is happening currently with muisc and audio. So nobody is right in this little dispute, they are all wrong. They are cutting off their noses to spite their faces.
// Anonymous Anonymous // 8:31 AM

This is insane people. Take a look at this debate with a clear head for one moment and it's pretty clear that Apple is making a mistake by attacking Real.

1. The DMCA is a questionable law. Nearly every civil rights organization in the US is lobbying to get it overturned. It's only a matter of time before we win this fight and all decisions based on this law become irrelevant. Apple is not planning for the long term by using the DMCA to protect themselves.

2. Real is providing a vastly inferior product. Who in their right mind is going to listen to Real's garbage on their iPod (or anywhere else for that matter)? Sure, if you're a new computer user and you don't have an iPod, you don't know what good content sounds like. But anyone who bought an iPod already knows what good content sounds like. The first time these people fire up Harmony, they will regret using it. Apple doesn't need to attack Real, Real will attack themselves with the inferiority of their offering.

3. DRM in general is just plain stupid. From a purely technical standpoint, it makes no sense. Circumvention of any DRM is a trivial task compared to really any other kind of cryptographic protection. If Apple was really betting the farm on the security of FairPlay, then they're dumb enough to deserve to lose. Which saddens me because I really like Apple and I really like their products. But this is just too stupidly hair-brained to let slide without reproach.

4. Nothing that is totally closed encourages innovation. We as a society have known this for centuries. The purpose of copyright law is not solely to protect copyright holders. The purpose has always been to balance the rights of copyright holders with the rights of society as a whole to a shared cultural and intellectual heritage. Apple (and hundreds of others) has clearly forgotten this. Anti-circumvention law is a violation of the right to private ownership. With the DMCA on the books, you can never really own your iPod. You paid for it, but if you tamper with it, you are not just altering your own private property, you are now violating copyright law and face criminal prosecution. Bull****!. This is not the purpose of IP law. This is a perversion of copyright law and Apple (and the RIAA) needs to rethink their strategy if they want to survive the music business in the future. This will not stand in the long run. It is not in the best interests of this country, nor is it in the best interests of Apple.

Apple needs to wake up, realize how minor a threat Harmony really poses to them, chill out and watch Real shoot themselves in the foot when their offering still can't hold up to iTunes even when it works on an iPod. I hate to see Apple make themselves the bad guy, but that's exactly what they're doing right now. They are using a bad law to wage a losing war against the best interests of our society as a whole.

This is a strange move from the company that used open source to revolutionize the Mac OS. They of all companies should know the power of openness in the marketplace.
// Anonymous Anonymous // 5:32 PM

I hope Apple wins big time. The are creating and recreating the best product in the segment. they are innovating endlessly. I hope they never lose this fire. Personally, I don't care if Real gets access to Apple's technology. As of this writing, their product is inferior.

Someday, I hope that much if not most music will be sold digitally in great quality formats without DRM. The RIAA and P2P are the bad guys.

There are some great economic theory arguments wht Apple should open. The quality of their product is not one. No one can come close to offering the total package that Apple offers already. I hope they continue to innovate and leave everyone else in the dust.

The problem I see is if everyone else starts using WMA, which would in time give Microsoft critical mass, and at some point there would be services that are good enough on players that are good enough. Sony just made a decent competing HD player, just not an iPod killer because they can't forget about their proprietary formats like '8-track" -- pun intended -- . No one has the complete package yet. Not even Real, they hope to steal part of Apple's package, but even then then their offering is inferior.

Apple needs to make business decisions about what is best for Apple. It's great for us to consider what great for society. Apple will rise or fall based on their decions and the $$'s and �� that follow from those decisions today and in the future. The need to analyze and figure out which part of the pie the most important and defend that part to the death. The correct part to defend would be whatever would give them control over this industry --

Microsoft obtained exclusive right to the OS on the IBM computer, and encouraged other hardware manufacturers to compete with IBM. IBM made a bad strategic choice. IBM could be today's Microsoft. Microsoft would be one of many software companies. The software marketplace would be more competitive without Microsoft having stifling control. We would not be paying hundreds of dollars for Windows and then hundreds of dollars again for office productivity software and thousands for server and client licenses for networks etc.

This is totally about what is best for Apple -- short-term and long-term. They need to find the best balance between getting paid today for their innovations and finding a way to translate this market leadership into control of the digital music distribution industry.

It will be good for all that it not be Microsoft in control AGAIN of another technology and another industry. Microsoft has this industry and many others in their crosshairs. Remember their prevoius targets -- IBM, Mac, Netscape, Palm, the flourishing software industry of the 80's, etc.

Microsoft wants to have control over our lives and use that control to monetize a revenue stream. Beware!!
// Blogger TimesSquareView // 6:14 PM
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