What is Holding Apple Back in Software and Services?

As the smartphone market matures, Apple will need to shift from selling hardware to selling more software and services to its extremely loyal customer base. Tim Cook and Luca Maestri know this and pointed it out during the Q1 2016 earnings call.

Especially during a period of economic uncertainty, we believe it is important to appreciate that a significant portion of Apple’s revenue recurs over time…a growing portion of our revenue is directly driven by our existing install base. Because our customers are very satisfied and engaged, they spend a lot of time on their devices and purchase apps, content, and other services. – Tim Cook

And Luca.

Each quarter, we report results for our Services category, which includes revenue from iTunes, the App Store, AppleCare, iCloud, Apple Pay, licensing, and some other items. Today, we would like to highlight the major drivers of growth in this category, which we have summarized on page three of our supplemental material. – Luca Maestri

It’s great that management knows it needs to monetize its customer base better. Especially when iPhone Users spend on average more than any other smartphone user. The problem is Apple isn’t very good at services, software, and subscriptions. With customers that spend the most money than other smartphone users, Apple isn’t number one in any cloud based services.

Also, Apple is lagging behind its rivals when it comes to analytics. With such a valuable customer base imagine if Apple’s analytics and were like Amazon’s? Apple would be monetizing their customer base at such a higher rate.

Why is Apple Bad at Services?

Apple is really good at making very desireable high-end hardware. So what is holding them back at software?

It may be their organizational structure. Apple operates under the “Unitary Organizational Form”.

Image courtesy of Stratechery. Click Image to enlarge.

Image courtesy of Stratechery. Click Image to enlarge.

The “Unitary Organizational Form” has served Apple well in building and selling great hardware but it has some disadvantages to selling software. Ben Thompson Elaborates.

The problem is that everything that goes into creating these jewel-like devices works against being good at services:

    • You only get one shot to get a device right, so all of Apple’s internal rhythms and processes are organized around delivering as perfect a product as possible at a specific moment in time.

      Services, on the other hand, which are subject to an effectively infinite number of variables ranging from bandwidth to device capability to hacking attempts to data integrity to power outages — the list goes on and on — can never be perfect; the ideal go-to-market is releasing a minimum viable product that is engineered for resiliency and then updated multiple times a week if not multiple times a day. The rhythms and processes are the exact opposite of what is required to build a great device.

 

    • As Apple is happy to tell you, a superior experience on a device comes from integration: the software can be tailored to the hardware, all the way down to the component level; this is why Apple designs their own system-on-a-chip hand-in-hand with iOS. Integration to this degree, though, is only possible when there is a static endpoint: the device that goes on sale to the public.

      In the case of services, though, which develop organically and iteratively, an integrated approach is unworkable: you can’t build everything from scratch multiple times a day. Rather, an effective set of services are modular in the extreme: different capabilities snap together like lego blocks to deliver different types of experiences, and each of those capabilities can be iterated on without disrupting the end product.

 

  • The fact that smartphones are such an important part of people’s lives, combined with the fact that physical objects can have additional consumer benefits like status, enables Apple to sell each iPhone with a huge amount of margin. However, not everyone values smartphones that much, or has the willingness to pay, which means Apple has to be ok with not serving the entire market; after all, to make a single iPhone costs money that has to be made up for in the purchase price.

    Services, though, have a very different business model. First, there is precious little evidencethat consumers are willing to pay more than a nominal amount for services (if that!), which means the most profitable services make money through volume. Secondly, services are effectively free on a marginal basis; the real costs are fixed, which means that services business have a strong economic imperative to reach as many people as possible.

These differences get at the very fundamental reasons why Apple struggles with services: it’s not that the company is incompetent, but rather that the company is brilliant — brilliant at making devices, which require completely different business structures and incentives.

Apple has other opportunities to grow. Software and services is one of them. The question is can Apple rise above its mediocre past in sfotware and services to capitalize on this opportunity?

Sources:

Apple’s Organizational Crossroads (Stratechery)

Why Apple Must Move Beyond the ‘Wow’ Moment (Knowledge @ Wharton)