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Apple Inc. in 2012

Apple Inc. in 2012

Read the case, bring 3 questions you have. Then under each question, brief explain why the questions are important to ask. (The reason you ask the questions). Each explanation only needs 4-5 sentences, no more than 5 sentences.

Below is the case:

 

Apple Inc. in 2012

 

On October 5, 2011, Steve Jobs tragically died of cancer. The recently retired CEO of Apple Inc. was a legend: he had changed Apple from a company on the verge of bankruptcy to one of the largest and most profitable companies in the world. Moreover, he had revolutionized several industries in the process. Few companies’ successes were so closely identified with its CEO. Jobs’s passing promised to usher in a new era at Apple. The new CEO, Tim Cook, had an extraordinary challenge: how to sustain Apple’s current successes in computers, MP3 players, phones, and tablets, while taking Apple to the next level.

The company began as “Apple Computer,” best known for its Macintosh personal computers (PCs) in the 1980s and 1990s. Despite a strong brand, rapid growth, and high profits in the late 1980s, Apple almost went bankrupt in 1996. Then Jobs went to work, transforming Apple Computer into “Apple Inc.” with innovative non-PC products, starting in the early 2000s. In fact, Apple viewed itself as a “mobile device company.”1 By 2011, Macintosh revenues were less than 20% of Apple’s $108 billion in sales2 (see Exhibits 1a through 1c for financial information and net and unit sales). Meanwhile, Apple’s stock was making history of its own. Apple became the most valuable company in the world in 2012 (see Exhibit 2 for Apple’s share price over time).

By almost any measure, Apple’s accomplishments in the prior decade had been spectacular. Yet Cook knew that no company in the technology industry could relax. Challenges abounded. iPod sales, for example, had been falling for four straight years by 2012. At the same time, Microsoft was set to introduce Windows 8, which the company promised would challenge Apple’s vaunted leadership in user interface. Even though Macintosh sales had grown faster than the industry in recent years, Apple’s share of the worldwide PC market had remained below 5% since 1997 (see Exhibit 3a for Apple’s PC market share, worldwide). Many also wondered if the company could thrive without Jobs. Cook, Jobs’s former chief operating officer, had built Apple’s formidable global supply chain, but he came to the CEO job with a very different skill set. Finally, would the iPhone continue its march to dominate smartphones in the face of growing competition from companies such as Google and Samsung? And would Apple’s newest creation, the iPad, continue to dominate the tablet market, or would new competitors, ranging from Amazon to Samsung, steal share and drive down profits?

Apple’s History

Steve Jobs and Steve Wozniak, a pair of 20-something college dropouts, founded Apple Computer on April Fool’s Day, 1976.3 Working out of the Jobs family garage in Los Altos, California, they built a computer circuit board that they named the Apple I. Within several months, they had made 200 units and had taken on a new partner—A.C. “Mike” Markkula Jr., who was instrumental in attracting venture capital as the experienced businessman on the team. Jobs’s mission was to bring an easy-to- use computer to market, which led to the release of the Apple II in April 1978. It sparked a computing revolution that drove the PC industry to $1 billion in annual sales in less than three years.4 Apple quickly became the industry leader, selling more than 100,000 Apple IIs by the end of 1980. In December 1980, Apple launched a successful IPO.

Apple’s competitive position changed fundamentally in 1981 when IBM entered the PC market. The IBM PC, which used Microsoft’s DOS operating system (OS) and a microprocessor (also called a CPU) from Intel, was a relatively “open” system that other producers could clone. Apple, on the other hand, practiced horizontal and vertical integration. It relied on its own proprietary designs and refused to license its hardware to third parties.

IBM PCs not only gained more market share, but also emerged as the new standard for the industry. Apple responded by introducing the Macintosh in 1984. The Mac marked a breakthrough in ease of use, industrial design, and technical elegance. However, the Mac’s slow processor speed and lack of compatible software limited sales. Apple’s net income fell 62% between 1981 and 1984, sending the company into a crisis. Jobs, who was often referred to as the “soul” of the company, was forced out in 1985.5 The boardroom coup left John Sculley, the executive whom Jobs had actively recruited from Pepsi-Cola for his marketing skills, alone at the helm.

The Sculley Years, 1985–1993

Sculley pushed the Mac into new markets, most notably in desktop publishing and education. Apple’s desktop market was driven by its superior software, such as Aldus (later Adobe) PageMaker, and peripherals, such as laser printers. In education, Apple grabbed more than half the market. Apple’s worldwide market share recovered and stabilized at around 8% (see Exhibit 3a). By 1990, Apple had $1 billion in cash and was the most profitable PC company in the world.

Apple offered its customers a complete desktop solution, including hardware, software, and peripherals that allowed them to simply “plug and play.” Apple also stood out for typically designing its products from scratch, using unique chips, disk drives, and monitors. IBM-compatibles narrowed the gap in ease of use in 1990 when Microsoft released Windows 3.0. Still, as one analyst noted, “the majority of IBM and compatible users ‘put up’ with their machines, but Apple’s customers ‘love’ their Macs.”6

Macintosh’s loyal customers allowed Apple to sell its products at a premium price. Top-of-the-line Macs went for as much as $10,000, and gross profit hovered around an enviable 50%. However, as IBM-compatible prices dropped, Macs appeared overpriced by comparison. As the volume leader, IBM compatibles were also attracting the vast majority of new applications. Moreover, Apple’s cost structure was high: Apple devoted 9% of sales to research and development (R&D), compared with 5% at Compaq, and only 1% at many other IBM-clone manufacturers. After taking on the chief technology officer title in 1990, Sculley tried to move Apple into the mainstream by becoming a low- cost producer of computers with mass-market appeal. For instance, the Mac Classic, a $999 computer, was designed to compete head-to-head with low-priced IBM clones.

Sculley also chose to forge an alliance with Apple’s foremost rival, IBM. They worked on two joint ventures; one to create a new PC OS and one aimed at multimedia applications. Apple undertook another cooperative project involving Novell and Intel to rework the Mac OS to run on Intel chips that boasted faster processing speed. These projects, coupled with an ambition to bring out new “hit” products every 6 to 12 months, led to a full-scale assault on the PC industry. Yet Apple’s gross margin dropped to 34%, 14 points below the company’s 10-year average. In June 1993, Sculley was replaced by Michael Spindler, the company’s president.

The Spindler and Amelio Years, 1993–1997

Spindler killed the plan to put the Mac OS on Intel chips and announced that Apple would license a handful of companies to make Mac clones. He tried to slash costs, which included cutting 16% of Apple’s workforce, and pushed for international growth. In 1992, 45% of Apple’s sales came from outside the United States. Yet despite these efforts, Apple lost momentum: a 1995 Computerworld survey found that none of the Windows users would consider buying a Mac, while more than half the Apple users expected to buy an Intel-based PC7 (see Exhibit 4 for shipments and installed base of PC microprocessors). Spindler, like his predecessor, had high hopes for a revolutionary OS that would turn around the company’s fate. But at the end of 1995, Apple and IBM parted ways on their joint ventures. After spending more than $500 million, neither side wanted to switch to a new technology.8 Following a $69 million loss in Apple’s first fiscal quarter of 1996, the company appointed another new CEO, Gilbert Amelio, an Apple board member.9

Amelio proclaimed that Apple would return to its premium-price differentiation strategy. Yet Macintosh sales fell amid Apple’s failure to produce a new OS that would keep it ahead of Microsoft’s Windows 95. In December 1996, Amelio announced the acquisition of NeXT Software (founded by Jobs after he left Apple) and plans to develop a new OS based on NeXT. Jobs also returned to Apple as a part-time adviser. Despite more job cuts and restructuring efforts, Apple lost $1.6 billion under Amelio and its worldwide market share tumbled to around 3% (see Exhibit 3a). At one point, insiders believed that Apple was within 90 days of bankruptcy. To save the company, Jobs became the company’s interim CEO in September 1997.

Steve Jobs and the Apple Turnaround

Jobs moved quickly to reshape Apple. In August 1997, Apple announced that Microsoft would invest $150 million in Apple and make a five-year commitment to develop core products, such as Microsoft Office, for the Mac. Jobs abruptly halted the Macintosh licensing program. Almost 99% of customers who had bought clones were existing Mac users, cannibalizing Apple’s profits.10 Jobs also refused to license the latest Mac OS. Apple’s 15 product lines were slashed to just four categories— desktop and portable Macintoshes, for consumers and professionals. Other restructuring efforts involved hiring Taiwanese contract assemblers to manufacture Mac products and revamping Apple’s distribution system from smaller outlets to national chains. Tim Cook, hired by Jobs in 1998 after a career in operations at Compaq, IBM, and Intelligent Electronics, was credited with closing Apple’s factories and streamlining the supply chain. In addition, Apple launched a website to set up direct sales for the first time. Internally, Jobs focused on reinvigorating innovation. Apple pared down its inventory significantly and increased its spending on R&D (see Exhibit 5 for PC manufacturers’ key operating measures).

Jobs sought to bring a new culture to Apple. While previous CEOs sought to broaden Apple’s products, Jobs believed deeply in focus. Apple had one of the narrowest product lines of any company of comparable size. Jobs also believed in extreme practices of secrecy, including a “closed door policy” in which key cards accessed only certain areas and dummy positions for new hires until they could be trusted. Everyone knew that violation of Apple’s culture of confidentiality was immediate grounds for termination.11 Employees reported that working with Jobs was rewarding, but often difficult. Jobs noted that “I don’t think I run roughshod over people, but if something sucks, I tell people to their face.”12 “My passion,” noted Jobs, “has been to build an enduring company where people were motivated to make great products. Everything else was secondary.”13 Jobs was especially fanatic about industrial design, simplicity, and product elegance.

This approach led to Jobs’s first real coup—the iMac—introduced in August 1998. The $1,299 all- in-one computer featured colorful translucent cases with a distinctive eggshell design. The iMac also supported “plug-and-play” peripherals, such as printers, that were designed for Windows-based machines for the first time. Thanks to the iMac, Apple’s sales outpaced the industry’s average for the first time in years. Following Jobs’s return, Apple posted a $309 million profit in its 1998 fiscal year, reversing the previous year’s $1 billion loss.

Another priority for Jobs was to break away from Apple’s tired, tarnished image. Jobs wanted Apple to be a cultural force. Not coincidentally, perhaps, Jobs retained his position as CEO of Pixar, an animation studio that he had bought in 1986. (Jobs later sold Pixar to Walt Disney for $7.4 billion in 2006.) Through multimillion-dollar marketing campaigns such as the successful “Think Different” ads and catchy slogans (“The ultimate all-in-one design,” “It just works”), Apple promoted itself as a hip alternative to other computer brands. Apple ads were placed in popular and fashion magazines as well, venturing out from general computer publications. Later on, Apple highlighted its computers as the world’s “greenest lineup of notebooks” that were energy efficient and used recyclable materials.14 The goal was to differentiate the Macintosh amid intense competition in the PC industry.

The Personal Computer Industry

While Apple pioneered the first usable “personal” computing devices, it was IBM that brought PCs into the mainstream in the 1980s. But by the early 1990s, a new standard known as “Wintel” (the Windows OS combined with an Intel processor) dominated the industry. Thousands of manufacturers—ranging from Dell Computer to no-name clone makers—built PCs around standard building blocks from Microsoft and Intel. Growth was driven by lower prices and expanding capabilities. The overall industry continued to boom through the early 2000s, propelled by Internet demand and emerging markets such as China. Although volume growth slowed over the next decade, analysts predicted that more than 2 billion PCs would be used worldwide by 2015.15

Slowing revenue growth followed the slowdown in volume. Despite PCs that were faster, with more memory and storage, average selling prices (ASPs) declined by a compound annual rate of 8%– 10% per year from the early 1990s through 2005.16 The rate of decline in ASP lessened between 2006 and 2011 to a compound annual rate of 2%.17 By 2011, the average PC manufacturers’ net profit margin, excluding Apple, was 5%.18 The standardization of components led PC makers to cut spending on R&D to between 1% and 3% of revenue19 (see Exhibit 5). As contract manufacturing in Taiwan and China became popular, Asian firms took over responsibility for more innovations, such as industrial designs. New PC products emerged as well. Laptop computers started to gain traction in the late 1980s. Three decades later, portable PCs represented about 60% of worldwide PC shipments.20 The growth in demand for laptops was linked to lower prices: the ASP for a portable PC was $746 in 2011,21 down 25% in only three years.22

A new subproduct category of netbooks took off during the global economic downturn in 2009. These lightweight mini notebooks had limited storage and were optimized for the Web. Price-sensitive consumers loved the roughly $400 average price.23 Initial interest in the category was huge: more than 40 million netbooks sold in 2009. But the emergence of the iPad in 2010 led to a rapid decline. Yet another category of laptops called Ultrabooks came to the market in 2011. These ultra- thin, lightweight, Windows-based notebooks were high-performance PCs, which manufacturers hoped would ignite new demand and accelerate replacement cycles as prices came down.24

Buyers and Distribution

PC buyers fell into five categories: home, small and medium-sized business (SMB), corporate, education, and government. Home consumers represented the biggest segment, accounting for nearly half of worldwide PC shipments.25 While all buyers cared deeply about price, home consumers also valued design, mobility, and wireless connectivity, business consumers balanced price with service and support, and education buyers depended on software availability.

In distribution, a significant shift occurred in the early 1990s when more knowledgeable PC customers moved away from full-service dealers that primarily sold established brands to business managers. Instead, larger enterprises bought directly from the manufacturer, while home and SMB customers started to buy PCs through superstores (Walmart, Costco), electronics retailers (Best Buy), and Web-based retailers. At the same time, the so-called “white box” channel—which featured generic machines assembled by local entrepreneurs—represented a large channel for PC sales, especially in emerging markets. White-box PCs reportedly represented about 30% of the overall market in 2011, and were most frequently sold to small offices and home offices.26

PC Manufacturers

The four top PC vendors—Hewlett-Packard, Dell, Lenovo, and Acer—accounted for 53.6% of worldwide shipments in 2011 (see Exhibit 3b for PC manufacturers’ market shares). Industry leadership had shifted numerous times in the prior three decades, with Hewlett-Packard (HP) emerging as the most recent leader. Following a rough period after the acquisition of Compaq Computer in 2002, HP outsourced most of its production to Asia and dramatically lowered its costs. But HP’s PC leadership came with a high price: since 2005, HP market share eroded, margins declined, and the board fired three CEOs.27 HP proposed selling or spinning off PCs in 2011, then recanted. Nonetheless, HP held on to the number-one position in worldwide shipment market share at 17.7%.28

Dell held the second-largest market share with 12.6% of worldwide PC shipments for 2011.29 Its distinct combination of direct sales and build-to-order manufacturing was popular in the corporate market for a decade. Yet when a boom in retail consumer PCs outpaced corporate sales, Dell was late to catch on. Founder Michael Dell returned as CEO in January 2007 and emphasized consumer- friendly products, reentered retail distribution, and pushed for international expansion. Still, Dell struggled with cost controls and poor margins. China-based Lenovo vaulted into the front ranks of PC vendors in 2005 when it acquired IBM’s money-losing PC business for $1.75 billion. The upward trend continued through 2011 when Lenovo’s worldwide share grew to 12.5%.30 Lenovo’s greatest strength was its dominant position in China, the fastest-growing PC market in the world, where it commanded 35% share.31 In 2007, Taiwan-based Acer bought Gateway, a leading U.S. PC brand, and became the third-largest PC vendor in the world. Acer also acquired Packard-Bell, a PC maker with a strong presence in Europe (where Acer also was a leading brand). Acer’s success was partly a function of its leadership in netbooks,32 but the company lost its third-place ranking largely due to declining netbook sales. Suppliers, Complements, and Substitutes

Suppliers to the PC industry fell into two categories: those that made products (such as memory chips, disk drives, and keyboards) with many sources; and those that made products—notably microprocessors and operating systems—that had just a few sources. Products in the first category were widely available at highly competitive prices. Products in the second category were supplied chiefly by two firms: Intel and Microsoft.

Microprocessors Microprocessors, or CPUs, were the hardware “brains” of a PC. Intel commanded roughly 80% of the PC CPU market. Competition emerged in the 1990s from companies like Advanced Micro Devices (19.6% in the fourth quarter of 2011) and VIA Technologies (0.1% in the fourth quarter of 2011).33 Still, Intel remained the market leader with leading-edge technology, manufacturing scale, and a powerful brand. Since 1970, CPU prices (adjusted for changes in computing power) had dropped by an average of 30% per year.34 Performance of CPUs continued to double roughly every 18 to 24 months, but prices for microprocessors had stabilized in recent years. However, ARM, a low-power, lower-performance, and lower-priced CPU that was used in smartphones, was expected to enter the PC market in 2012.

Operating system An OS was the software that managed a PC’s resources and supported its applications. Microsoft had dominated this market since the IBM PC in the 1980s. More than 90% of all PCs in the world ran on some version of Windows. Microsoft’s big hit in the new millennium was Windows XP. Introduced in October 2001, 17 million copies of XP were sold in its first eight weeks of sales. Developed at a cost of $1 billion, XP initially garnered for Microsoft between $45 and $60 in revenue per copy.35 Vista, the next version introduced in 2007, did not fare as well. Consumers complained about its sluggish performance and were reluctant to upgrade to Vista. Two years later, Windows 7 was released to strong reviews. Analysts estimated that Microsoft spent $1.5 billion to develop Windows 7 and another $1 billion in marketing. Microsoft shipped over 100 million units of the new OS in the first six months, making it the fastest-selling OS in history.36 In 2012, Microsoft was betting heavily on its next-generation product, Windows 8. Expected in fall 2012, the OS included a new user interface that would incorporate touch and would be available for PCs as well as tablets. Microsoft was also making Windows 8 available on an Intel and a non-Intel (ARM) CPU for the first time. Windows 8 on ARM would not be compatible with most existing Windows software.

Application software, content, and complementary products The value of a computer corresponded directly to the complementary software, content, and hardware that were available on that platform. Key application software included word processing, presentation graphics, desktop publishing, and Internet browsing. Since the early 1990s, the number of applications available on PCs exploded, while ASPs for PC software collapsed. Microsoft was the largest vendor of software for Wintel PCs and, aside from Apple itself, for Macs as well.37 Firms such as Google even offered productivity software (Google Apps) for free. PCs also benefited from a wide selection of content, and a vast array of complementary hardware, ranging from printers to multimedia devices. The number of new, exciting PC applications had slowed considerably in recent years, as software developers increasingly focused on new devices, such as phones and tablets.

Alternative technologies Since the early 2000s, consumer electronics (CE) products, ranging from cellphones to TV set-top boxes to game consoles, started to encroach on functionality that was once the sole purview of the PC. For example, advanced game devices like Sony PlayStation 3 allowed consumers to watch DVDs, surf the Web, and play games directly online in addition to playing traditional video games. At the same time, smartphones increasingly functioned as handheld computers, allowing users to do e-mail, visit websites, and manage their online lives. Despite being in the market since the 1980s, tablet computers failed to gain significant ground until the introduction of the iPad in 2010.38 Sales of tablets exploded to more than 60 million units in 2011. While several industry insiders worried about the impact of digital devices on the PC industry, Jobs viewed all of these devices as part of an integrated strategy to deliver breakthrough user experiences.

The Macintosh and Apple’s “Digital Hub” Strategy

In 2001, marking Apple’s 25th anniversary, Jobs presented his vision for the Macintosh in what he called the “digital hub.” He believed that the Macintosh had a real advantage for consumers who were becoming entrenched in a digital lifestyle, using digital cameras, portable music players, and digital camcorders, not to mention mobile phones. The Mac could be the preferred “hub” to control, integrate, and add value to these devices. Jobs viewed Apple’s control of both hardware and software, one of the few remaining in the PC industry, as a unique strength.

Apple subsequently revamped its product line to offer machines that could deliver a cutting-edge, tightly integrated user experience. Although the company remained committed to the education market, new PC products focused on home consumers’ lifestyles. Apple’s computer sales were growing faster than the industry. Thanks to creative marketing and several innovative computer products, such as the ultra-thin Mac Air, Apple became the third-largest PC vendor in the U.S. with an 11.0% unit share in Q4 2011.39 The company’s greatest strength lay in the premium-priced PC category; 91% of PCs priced above $1,000 in the U.S. market were sold by Apple.40 Globally, Apple’s market share had risen steadily since 2004, but remained below 5% at the end of 2011.41

Changing the Macintosh To accomplish his vision, Jobs made four important changes in the Macintosh: he delivered a new OS; he switched to a new chip architecture; he invested in a new suite of proprietary applications; and he bet on the Apple Store. First, and perhaps most important, Apple introduced a new OS in 2001, the first fully overhauled platform released since 1984. The Mac OS X was based on UNIX, a more stable, industrial-strength OS favored by computer professionals. Analysts estimated that OS X cost Apple roughly $1 billion to develop. Apple issued upgrades every 12 to 18 months, in greater frequency than Microsoft. Over time, Apple was slowly converging its computer OS with the OS on its iPhone and other digital devices.

Second, since the early 1990s, Apple had built Macs with an IBM CPU, called PowerPC. In 2006, Jobs made a large investment to shift Apple to Intel chips. By the next year, the entire Macintosh line ran on Intel.42 Critical to the Mac’s resurgence, Intel’s chips enabled Apple to build laptops that were both faster and less power-hungry.43 By 2011, notebooks accounted for 72%44 of all Macintosh sales compared to 38% nine years earlier. With “Intel Inside,” the Mac could also natively run Microsoft Windows along with Windows applications. This capability potentially offset a long-standing disadvantage to choosing a Mac—the relative lack of Macintosh software.

The third element of the new Mac strategy was developing a proprietary set of applications. Building programs such as the iLife suite (iPhoto, iTunes, iWeb) required Apple to assume significant development costs.45 At the same time, the company continued to depend on the cooperation of key independent software vendors—especially Microsoft. In 2003, after Apple developed its Web browser Safari, Microsoft said it would no longer develop Internet Explorer for the Mac. However, Microsoft did continue to develop its Office suite for Macintosh. Full interoperability with Office products was critical to Macintosh’s viability. Jobs still hedged his bets by developing iWork productivity applications, including Pages, Keynote, and Numbers.46

The final piece of Jobs’s puzzle was a new distribution strategy. The first Apple retail store opened in McLean, Virginia, in 2001. Apple not only wanted consumers to look at the eye-catching Macintosh designs, but also wanted people to directly use and experience Apple’s software. The Apple retail experience gave many consumers their first exposure to the Macintosh product line. By 2011, the company estimated that more than half of all retail Mac sales were to new Mac customers.47 The retail division—with more than 300 stores in 13 countries—accounted for 13% of Apple’s total revenue.48 Observers viewed Apple’s retail strategy as a huge success: one analyst said that the company had become “the Nordstrom of technology.”49 Most analysts believed that the popularity of media products, such as the iPod, iPhone, and iPad, were critical to bringing consumers into the stores and exposing them to the Mac.

Moving Beyond the Macintosh

Apple’s shift toward a digital hub strategy was initiated by the debut of the iPod in 2001, followed by the iPhone in 2007, then the iPad in 2010. While the prospects for the Macintosh business had improved, it was the iPod that set Apple on its explosive growth path. Jobs’s focus for the iPod was simplicity: he said that “to make the iPod really easy to use—and this took a lot of arguing on my part—we needed to limit what the device itself would do. Instead we put functionality in iTunes on the computer. . . . So by owning the iTunes software and the iPod device, that allowed us to make the computer and the device work together, and it allowed us to put the complexity in the right place.”50

The iPod was initially one of many portable digital music players based on the MP3 standard. Thanks to its sleek design, simple user interface, and large storage, it soon became “an icon of the Digital Age.”51 While early MP3 players only stored an hour of music, the first iPod stored up to 1,000 songs and retailed for $399. Over the next several years, Apple delivered one new innovative design after another. In 2012, Apple continued to hold more than 70% of the U.S. MP3 market.52

The historical economics of the iPod were stellar by CE industry standards. The iPod nano, for example, had gross margins of around 40% in 2007.53 The biggest cost component for the nano was flash memory, which could account for more than half of the bill of materials. Recognizing the importance of flash memory, Apple invested in several memory producers in order to secure output at the best prices. By 2012, Apple was one of the largest purchasers of flash memory in the world.

Apple’s approach to developing and marketing the iPod was more open than its strategy for the Macintosh. The iPod could sync with Windows as well as a Mac. Apple also built an ecosystem with the iPod accessory market that ranged from fashionable cases to docking stations. For every $3 spent on an iPod, consumers spent another $1 on iPod add-on products.54 While iPods were available in all price segments, iPod ASPs generally ran $50 to $100 higher than the competition.55 At the hardware level, most players were roughly comparable to iPod models. Yet competitors found themselves at a major disadvantage with the emergence of Apple’s iTunes store.

iTunes Two features that differentiated Apple’s iPods were its iTunes desktop software, which synchronized iPods with computers, and its iTunes Music Store, which opened in April 2003. The two, in combination, completed Apple’s vision of an entertainment hub.56 The iTunes store was the first legal site that allowed music downloads on a pay-per-song basis. Visitors could pay $0.99 per song for a title offered by all five major record labels and by thousands of independent music labels. The downloaded songs could be played on the user’s computer, burned onto a CD, or transferred to an iPod. Within three days of launching the service, PC owners had downloaded 1 million copies of free iTunes software and had paid for 1 million songs.57 Customers loved the vast music selections and ease of use, transforming the iTunes store into the number-one music store in the world.58 By

October 2011, it had sold 16 billion songs and featured the world’s largest music catalog.59 Offerings expanded to include audiobooks, podcasts, books, movies, and TV shows.

The launch of the iTunes store had a galvanic impact on iPod sales. In the quarter before the release of iTunes, Apple sold only 78,000 iPods. After the iTunes launch, iPod sales shot up to 304,000 units in one quarter and exploded thereafter.60 The direct impact of iTunes on Apple’s profitability was far less impressive. Songs were priced at $0.69, $0.99, or $1.29 per download. Some content and many apps were free. On average, roughly 70% of the money Apple collected per download went to the music label that owned it, and about 20% went toward the cost of credit card processing. That left Apple with only about 10% of revenue per download, from which Apple had to pay for its website, along with other direct and indirect costs.61 In essence, Jobs had created a razor-and-blade business, only in reverse: the variable element (songs) served as a loss leader for a profit-driving durable good.62

Despite the success of iTunes, Apple had a tense relationship with content companies. They balked at its dominance of the digital music market. Music labels also saw their higher-priced CD sales pushed aside in favor of low-priced à la carte downloads. While Apple made high margins on hardware, content companies saw their margins erode in the digital world.

Competition Online music stores such as Amazon.com, Napster, and Walmart.com offered individual song downloads at competitive or discounted prices to iTunes. Some had subscription plans that allowed unlimited listening, starting at $5 per month. Most competitors offered songs to play on various devices, including the iPod. In addition to music streaming services, the iPod faced other challenges as well. Internet radio sites, such as Pandora, offered free streaming music. Spotify allowed users to create their own playlists, share them, and stream free music like a virtual MP3 player. In some markets, music labels made more money from Spotify than iTunes.63 By April 2012, most streaming music operators offered unlimited music streaming for $9.99 per month.

Beyond competition, Apple also worried about future demand for iPods. Jobs had two responses to these threats: In 2009, he bought Lala.com, a music streaming service. The deal raised speculations that Apple could be exploring an alternative model to store and play digital music, bypassing downloads on a media player altogether. And, of course, in June 2007, he introduced the iPhone. Jobs later noted, “If you don’t cannibalize yourself, someone else will.”64

The iPhone

At the January 2007 Macworld, Jobs introduced the iPhone, saying, “Every once in a while a revolutionary product comes along that changes everything. Today, we’re introducing three revolutionary products of this class. The first one is a widescreen iPod with touch controls. The second is a revolutionary mobile phone. And the third is a breakthrough Internet communications device. . . . These are not three separate devices, this is one device, and we are calling it iPhone.”65 Hailed as Time magazine’s “Invention of the Year,” the iPhone represented Apple’s bid to “reinvent the phone.”66 Two and a half years of development efforts had been devoted to the phone, guarded under intense secrecy, even among the company’s own employees. The estimated development cost was around $150 million.

Entry into mobile phones might have been a risky move for Apple. At the time, the industry was dominated by Nokia, Motorola, and Samsung, with roughly 60% market share. In addition, products were characterized by short product life cycles (averaging six to nine months) and sophisticated technology, including radio technology, where Apple had little experience. In distribution, Apple faced powerful cellular carriers such as T-Mobile and Vodafone, which controlled the networks and

often the phones used on those networks. In the U.S., the top two carriers—Verizon Wireless and AT&T—collectively controlled more than 60% of the market and their networks were “locked”: an AT&T phone would only work on AT&T’s network. Especially in the U.S., a handset manufacturer was usually dependent on the operator to provide a subsidy, which could lower the consumer’s purchase price of a new handset by $250 or more. In return, most consumers signed a two-year service contract with the carrier. Operators also maintained “walled gardens,” which required consumers to access content only from their own networks. Price competition was especially intense in emerging markets like China and India, where consumers bought phones for well under $100.

In the early days when a mobile phone’s foremost purpose was to make calls, consumers selected a handset based on its appearance and service provider. Starting in the mid-1990s, the industry’s preference shifted toward feature phones that offered more attractive hardware designs and user- friendly interfaces, pioneered by Nokia. Multimedia functions, such as a camera, were added as well. Then smartphones rose to prominence in the next decade. These high-end phones brought multiple functions together in the palm of one’s hand, serving as a mobile phone, Internet browser, e-mail, and work device as well as a media player.

The iPhone, however, changed the rules in the industry. A revolutionary 3.5-inch touch-screen interface placed commands at the touch of users’ fingertips without a physical keyboard. The iPhone’s entire system ran on a specially adapted version of Apple’s OS X platform called iOS. Above all, users found it intuitive to use. The first model was priced at $499 for an 8GB model. At that time, handsets that cost more than $300 accounted for only 5% of sales.67 Apple initially gave the iPhone to only one network operator in most markets. AT&T, the exclusive U.S. operator for the iPhone when it launched, did not provide a subsidy. Instead, AT&T agreed to an unprecedented revenue-sharing agreement with Apple, which gave Apple control over distribution, pricing, and branding.

The first-generation iPhone sold about 6 million units over five quarters. However, more than a million had been sold in the “grey market,” in which consumers bought iPhones from unauthorized resellers and used them on unsanctioned mobile networks. Apple’s demand for a share of service revenue had led to only a few markets in the world with legal iPhone distribution. One estimate suggested that Apple could lose $1 billion over three years from the loss of service-share revenue.68

The second iPhone model was released in 2008. This version ran on a faster 3G network. More importantly, Apple revamped its pricing model. Carriers provided a subsidy on the phone in exchange for dropping the revenue-sharing agreement, and some subsidies were $400 per phone or higher. Over the next few years, Apple released an upgraded iPhone every 12 to 15 months and greatly expanded distribution. With the release of the 4s in October 2011, Apple introduced Siri, a voice-activated technology that Apple bought in 2010. With Siri, the user could dictate texts, schedule appointments, ask questions, and send e-mails using voice commands.69

Apple’s relationship with carriers changed, too. In most markets in the world, Apple moved from a single carrier to multiple carriers selling iPhones. When Apple added new carriers, it had a reputation as a very tough negotiator: Sprint, for example, signed a four-year, $15 billion deal with Apple that committed the carrier to sell at least 24 million iPhones.70 With each new generation of product, Apple also dropped the price of prior generations. The combination of big subsidies, low prices on older models, and expanded distribution caused revenues and unit volumes to explode (see Exhibit 1b). As a result, Apple vied with Samsung for the largest market share in smartphones.71 Analysts also estimated that Apple generated more than 50% of the cellphone industry’s total profits, with less than 4% unit market share.72 Dating back to the early days of Apple, Jobs always preferred to control the critical technologies that would drive Apple’s differentiation. To grab greater control of mobile devices, Jobs bought two ARM microprocessor design companies for about $400 million between 2008 and 2010.73 The iPhone 4 series was Apple’s first phone powered by its own processor, dubbed the A4. Later, the iPhone 4s used the next-generation A5 processor, which was manufactured by Samsung and optimized to deliver Apple’s demanding specifications on battery life and performance.

Analysts estimated that Apple commanded a wholesale ASP of $659 from its iPhones,74 while competitors’ ASPs on roughly similar hardware ranged between $250 and $350. Falling component costs and design improvements helped to reduce the iPhone’s cost structure. One study showed that the bill of materials for the latest 16GB model was just under $188.75 The first iPhone with half the storage capacity cost around $220 to build.76 Apple’s drive to keep its costs down was often controversial. Apple had become one of the largest customers of Foxconn in China. After several suicides of Foxconn workers, Apple commissioned a study by the Fair Labor Association,77 which discovered “serious and pressing” violations of the FLA’s code of conduct as well as Chinese labor law. Cook promised quick action to bring Apple subcontractors into compliance.

Four years after its launch, the iPhone accounted for 44% of Apple’s total revenue.78 In countries such as China, the iPhone was just taking off in 2012: even without subsidies, Chinese consumers were willing to buy iPhones for prices approaching $1,000 USD. As countries such as China and India moved their faster 3G and ultimately 4G networks, demand for smartphones was expected to continue growing rapidly.

App Store One key driver behind the iPhone sensation was the launch of the Apple App Store in 2008. Software applications for PDAs and smartphones had been around for years. But Apple’s App Store was the first outlet that made it easy to distribute, access, and download applications directly onto the mobile phone. Many apps were free; even paid apps usually started at $0.99. The App Store was introduced as part of iTunes, which already had a huge following. Software developers also welcomed the App Store because Apple made it easier to reach consumers. Apple reserved the right to approve all applications and kept a 30% cut of the developer’s app sales.

The popularity of the App Store was stunning. In the first 18 months, 4 billion applications had been downloaded worldwide.79 By May 2012, more than 585,000 applications were available in categories ranging from games to business productivity programs (see Exhibit 7 for an overview of smartphone operating systems and app stores). Walt Mossberg of the Wall Street Journal claimed that, “the App Store is what makes your device worth the price.”80 Mobile apps had turned into a nice side business for Apple as well. In FY 2011, Apple generated $6.3 billion in revenues from the sale of music, books, and applications.81 Over time, Apple also paid out more than $4 billion to developers for the 25 billion apps downloaded to iPhones, iPods, and iPads.82

Competitors Similar to what happened with PCs, Apple’s competitors fell into two large categories: horizontal and vertical. Manufacturers such as Samsung Electronics, HTC, LG Electronics, and Motorola followed a horizontal approach, where they licensed their OS and built their own hardware.83 iPhone’s greatest competition in 2012 came from Android, an open and free platform developed by Google. A consortium of 84 handset makers, chips makers, and operators, known as the Open Handset Alliance, backed the platform. As more manufacturers entered the market, innovation on the Android platform exploded. Leading-edge phones from Samsung, HTC, and others had larger, brighter screens than the iPhone, some with better cameras, improved audio, and so on. Some firms also added their own user interface and applications on top of Android. Not surprisingly, developers saw a potentially large market that might rival Apple. The combination of such factors powered the platform to become the most popular smartphone OS in 2011 (see Exhibit 8 for smartphone sales).

Among handset manufacturers, Samsung was Apple’s most direct competitor. Samsung was relatively late to enter the smartphone segment, but it became the volume leader in 2011 with the introduction of its Android-based Galaxy S2 handset. The Galaxy S2 used Samsung’s internally developed Super Amoled screen, considered the brightest in the industry.84 Analysts estimated that smartphones were generating as much as 80% of the operating profits in Samsung’s mobile division.85 While Android represented the majority of Samsung’s OS strategy, the company also worked with Windows Phone, Tizen, and Bada, a platform created by Samsung itself. Samsung was a huge company that made chips, PCs, TVs, and appliances as well as phones (see Exhibit 6 for financials of Apple competitors).

HTC, based in Taiwan, had pioneered several smartphone innovations, including being first to market with Android, 3G, and 4G phones. As iPhone and Samsung sales outpaced the industry in late 2011, HTC remained large and profitable, but lost market share.86 LG Electronics, a leader in feature phones, struggled to reverse its operating losses and change its image as a laggard.87 Motorola Mobility, which had suffered from a lack of scale and poor operating margins, was bought by Google for $12.5 billion, in a deal expected to close in mid-2012. Analysts speculated that Google needed Motorola’s intellectual property. All of these Android-based firms had aggressive plans to launch new handsets to compete with Apple in 2012.

Research In Motion (RIM) and, to a lesser extent, Nokia took a vertical approach by controlling both hardware and software. RIM’s BlackBerry smartphones historically delivered one of the best mobile e-mail experiences and was a popular choice among corporate consumers. But the popularity of iPhone and Android smartphones pressured RIM’s business.88 In 2012, RIM was rapidly losing market share.89 Nokia suffered the greatest decline. The biggest cellphone company in the world for more than a decade, the company’s strength had been in Europe and emerging markets. However, aggressive price competition from Chinese companies in feature phones, and virtually no presence in the key U.S. market for smartphones, was taking a toll. By 2012, Nokia had abandoned its own OS, Symbian, and shifted to Microsoft’s new Windows phone. Despite some good reviews for its Windows phones, Nokia announced large operating losses in early 2012, as it lost share in both traditional phones and smartphones.

Google’s competitor to Apple’s App Store, called Play Store, surged in 2010–2011. The number of Android applications was rapidly approaching iPhone apps (see Exhibit 7). A survey of developers in 2010 suggested that 87% were very interested in developing iPhone apps; 81% for Android apps; BlackBerry and Microsoft were far behind.90 While Google had fewer restrictions than Apple,91 developers found it more challenging to write applications for Android. Most Android phones varied slightly, which required software developers to write numerous versions of their apps. An Apple developer only worried about one iPhone.

The patent wars Intense competition in the smartphone industries led to numerous lawsuits on design and intellectual property.92 Literally, everyone in the industry sued everyone. Jobs, though, was the most aggressive CEO in pursuing legal redress. “From the earliest days at Apple, I realized that we thrived when we created intellectual property. . . . If protection of intellectual property begins to disappear, creative companies will disappear or never get started. But there’s a simpler reason: It’s wrong to steal. It hurts other people. And it hurts your own character.”93 In 2010, Apple initiated litigations against Android devices, first against HTC and then Samsung. Jobs explained, “I will spend every penny of Apple’s $40 billion in the bank, to right this wrong. I’m going to destroy

Android, because it’s a stolen product. I’m willing to go to thermonuclear war on this. They are scared to death, because they know they are guilty.”94

iPhone critiques While reviews of the iPhone were generally glowing, some people complained about its inability to run on the faster 4G LTE networks in 2012, its limited battery life, as well as its lack of support for Adobe Flash, which made some websites unusable for iPhone users. Although many Siri users in the U.S. were big fans, international users found that Siri did not work well in other languages or with non-American accents. At the same time, some carriers complained about the volume demands and huge subsidies required by Apple. For example, Verizon’s chief financial officer publicly announced that his company would aggressively support Microsoft in 2012 to create a “third ecosystem,” in a thinly veiled attack on Apple.95

Yet despite these criticisms, the iPhone exceeded all expectations. With the iPhone on a roll, Jobs saw another opportunity to make a bold move to redefine computing with the launch of the iPad. “Some people say, ‘Give the customers what they want,’” said Jobs, “but that’s not my approach. Our job is to figure out what they’re going to want before they do.”96 That was what he did with the iPad.

The iPad

Apple’s release of the iPad on March 2, 2010, defined a new device category that was described by Jobs as “even more intuitive and easier to use than a PC, and where the software and the hardware and the applications need to be intertwined in an even more seamless way than they are on a PC.”97 Prior to the iPad, tablet sales accounted for a trivial share of the PC market. When the iPad launched, market demand was uncertain, at best. But doubters were quickly silenced, as sales of the new device took off. More than 450,000 iPads were sold during its first week on the market. Jobs commented, “It feels great to have the iPad launched into the world—it’s going to be a game changer.”98 In February 2012, Cook announced that 55 million iPads had been sold, surpassing even the most bullish analyst estimates.99 In less than two years, Apple had built another $35 billion business.

The iPad was originally priced from $499 to $829 and was sold in the U.S. by Apple retail stores, carriers, and other retail stores (Best Buy, Target, Staples). The tablet featured a 9.7-inch LED screen with a 10-hour battery life for reading books, watching movies, and some business productivity applications. Operators did not subsidize iPads, as they did smartphones. Consumers could choose to connect to the Internet by paying for access to a carrier’s network or rely exclusively on Wi-Fi networks. Most tablet owners opted for a Wi-Fi-only connection.100

Perhaps the biggest debate about the iPad was its usage model. Market research indicated that tablet owners viewed it primarily as a device to consume content rather than produce it.101 The most popular activities included checking e-mail, playing games, watching full-length videos, and shopping online. The iPad could run, with some limitations, almost all iPhone apps. To offset those limitations, software developers released over 1,000 applications specifically developed for the iPad at the time of its launch. By March 2012, the App Store had more than 200,000 native iPad apps.102 Over time, iPad consumers became more creative in finding uses for the iPad for everything from writing music to restaurant menus, sales tools, and even car owner manuals.

An early controversy over the iPad erupted when Apple sought to offer its own bookstore. Historically, Jobs had insisted on low prices for content on the iPod and iPhone ($0.99 for songs, and free or low-priced apps). But in trying to woo book and magazine publishers to the iPad, Jobs faced Amazon, which distributed 90% of the digital books on the market through its Kindle e-reader. To stimulate demand, Amazon priced many of its books at $9.99, often below Amazon’s costs. Publishers were unhappy with the pricing: they feared low prices would devalue the content as well as cause rapid cannibalization of physical books. Apple made an offer to publishers that they set their own prices, usually ranging from $12 to $15 for an e-book. Apple then took a 30% commission. After initially resisting, Amazon was forced by publishers to follow suit. By April 2012, Amazon’s market share in e-books had fallen to 60%.103 The Department of Justice, however, investigated Apple’s strategy in early 2012, accusing the company and five publishers of price fixing. Three companies settled, while Apple and two publishers chose to fight. Since the settlement gave digital retailers flexibility again in setting prices, Amazon almost immediately lowered prices back to $9.99 on some books.

Apple’s pricing and manufacturing for the iPad were also slightly different from earlier products. The entry retail price of $499 for an iPad was lower than the wholesale price of an iPhone. Despite the low price, Apple earned an estimated 25% gross margin on the entry model. By using its own CPU, giving the channel a lower margin, and leveraging its scale in purchasing, Apple had lower cost than most competitors, which could only make 15% gross margin at the same retail price.104 Apple also had at least a one-year lead. While some competitors, such as Microsoft, had not even gotten started in 2012, Apple was on its third-generation product. This provided Apple with opportunities to build its intellectual property position. For example, Apple had filed patents for its creative magnetic cover for the second- and third-generation iPads. Yet despite Apple’s formidable lead, at least 20 major manufacturers of mobile devices, PCs, and eReaders launched tablets by 2011 (see Exhibit 9 for worldwide tablet shipments).

Competition Android-based tablets were rushed to the market in late 2010, and by the end of 2011, Android held a 38% share.105 Apple had at least three potential serious competitors for tablets: (1) manufacturers using Google’s version of Android; (2) Amazon, which used an open source version of Android; and (3) forthcoming Microsoft-based tablets. In the first category, the leader was Samsung, which sold an estimated 5 million tablets in 2011.106 Samsung 9-inch tablets were very similar to the iPad in design and price, but Android lacked the applications and ease of use of an iPad. In 2012, Samsung bet heavily on the Samsung Note, a 5-inch combination tablet and phone.

Amazon, by contrast, had a different model: it developed a distinctive user interface and sold its 7-inch tablet, the Kindle Fire, for $199. Amazon’s product costs were estimated to be slightly more than $200.107 While Apple sought to make money on hardware, Amazon hoped to make money on software, applications, and content. Despite mixed reviews, analysts believed that Amazon grabbed 14% market share in Q4 2011.108 The greatest uncertainty for competition in tablets was Microsoft’s entry with Windows 8. Expected in the second half of 2012, some Windows 8 tablets would offer a new user interface and backward compatibility for Windows applications. Microsoft also hedged its bets by taking a $300 million, 17% stake in Barnes & Noble’s eReader, the Nook.

iCloud One of Jobs’s last acts as CEO was to prepare Apple for the launch of iCloud in October 2011. Jobs’s vision was that Apple was “the first to have the insight about your computer becoming a digital hub . . . [which] worked brilliantly. But over the next few years, the hub is going to move from your computer into the cloud. So it’s the same digital hub strategy, but the hub’s in a different place.”109 iCloud allowed users to synchronize seamlessly across multiple Apple devices by storing data, pictures, music, and so on, in one location on the Internet. Five GB of free cloud storage on iCloud was free for Mac, iPhone, iPad, and iPod Touch users. Consumers could also pay for additional storage.110 To support iCloud, Apple invested in a huge data center in North Carolina at an estimated cost of $500 million.111 Notably, iCloud worked only with Apple products. Following Apple’s lead, OS competitors such as Google and Microsoft offered their own cloud storage services, while product competitors such as HTC and Samsung struck deals with Dropbox. Although less elegant than iCloud, Dropbox was a cross-platform cloud storage solution that offered HTC and Samsung customers much more storage for free.

The Occasional Disappointments

While almost everything that Jobs touched in the first decade of the twenty-first century turned to gold, his record was not unblemished. Apple had two notable products that failed to live up to expectations. One was the Mac Mini. As Apple’s entry-level desktop, the $599 price tag did not come with a keyboard or a mouse. Consumers could buy a Windows desktop with more functions and faster performance at a lower price. The other disappointment was Apple TV. Introduced in 2007, the set-top box was Apple’s attempt to bring digital video content directly into consumers’ living rooms. Users could stream movies and TV shows over the Internet to a TV set and/or connect other Apple devices to the TV over a Wi-Fi connection. However Apple TV sales were paltry compared to Apple’s other products. Before he died, Jobs claimed to have cracked the code for a next-generation television, which Apple watchers expected to ship sometime in 2013 or 2014.

The Legacy of Steve Jobs

Few, if any, could disagree that Apple’s evolution from a failing PC manufacturer to a mobile device company had been a spectacular success. Most of the credit went to Jobs, the man who had “changed the rules” for the company and the industry, again and again. Of course, Jobs did not work alone. Steve Wozniak, with whom Jobs founded Apple Computer, was a key influence in his life and business even when no longer formally employed. The flawless ramping of Apple’s volume growth was orchestrated by the new CEO, Tim Cook. Jonathan Ive was the lead designer behind Apple’s products, including the iMac, MacBook Air, iPod, iPod Touch, iPhone, and the iPad. Jobs demonstrated his confidence in Ive and the importance of his role with Apple by giving him full control over the design process. Many more employees contributed to the unique culture behind Apple’s success. In the six months following Jobs’s death, only a small number of key employees left the company. The most notable was Ron Johnson, the architect behind Apple’s retail store strategy, who departed to become CEO of JCPenney.

Apple Inc. in the Next Decade?

Inevitably, many wondered about what would happen to Apple with Jobs gone. The history of technology companies was littered with speeding rockets headed to the sky, only to fall back to earth with a crash. In six short months, Cook had already shown that he would run Apple somewhat differently. Jobs, for example, had strongly opposed paying dividends and buying back stock, but Cook announced that he would do both in March 2012.112 And while Jobs was aggressive legally, Cook hinted at a more flexible approach: “I would highly prefer to settle versus battle [on intellectual property], but the key thing is that it’s very important that Apple not become the developer for the world.”113 Even with these differences, Apple had performed significantly above expectations in Cook’s first half-year. For a few weeks during the spring of 2012, Apple’s market capitalization surpassed $600 billion, making it the most valuable company in the history of the world. Moreover, after Jobs’s death, Apple’s board demonstrated its confidence in Cook by awarding him one of the largest compensation packages ever—almost $400 million in stock. With his board behind him and the business performing well, Cook was in a great position to make his own distinctive mark on Apple. The only question was how?

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