Daniel Eran Dilger
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Myths of Snow Leopard 7: Free?!

Daniel Eran Dilger
Apple’s limited comments on Snow Leopard, the next version of Mac OS X due in about a year, have opened the playing field for rampant speculation. Here’s a look at a series of myths that have developed around the upcoming release. The seventh myth of Snow Leopard:

Apple will have to give Snow Leopard away for free if it lacks many marketing features.

The idea of Snow Leopard being a maintenance release rather than a feature release has resulted in speculation that the company should or perhaps will have to offer it for free or at a greatly reduced cost. This is probably not the case, for a number of reasons.

1. Selling Snow Leopard for Less Would Make Selling 10.7 at Regular Price Rather Difficult.
If Apple sold Snow Leopard at a steep discount as an apology for not adding fluff features, it would deflate the perceived value of Apple’s operating system software. Additionally, the main group to benefit from Snow Leopard will be owners of recent, 64-bit Macs who are likely to willingly pay full price to fully unlock the power of their existing hardware.

Everyone else is just as likely to just wait for Snow Leopard until they buy their next new Mac and are able to take full advantage of its advances. Snow Leopard’s relatively limited audience means that any reduction in its price would have a limited impact on boosting retail sales volumes. At the same time, it would only make selling the next release of Mac OS X harder while offering less incentive for users to buy a new Mac.

Keeping the retail price of Snow Leopard unchanged wouldn’t help set any new sales records for a reference release of Mac OS X, but would help induce sales of new Macs, because buyers would think of new systems as including an additional $129 of software for free.

2. Apple Doesn’t Actually Make Much Money From Software Anyway.
Before Snow Leopard’s details were released, I suggested that Apple would likely ship a full price reference release around the first quarter of 2009, if for nothing else, just to continue raising the funds needed to invest in regular new operating system development.

Unlike Microsoft, Apple only earns direct profits on retail boxes of Mac OS X; it does not sell bundled licensing to other hardware makers. Microsoft’s software licensing model allowed it to continue making money on sales of Windows XP for years despite minimal feature enhancements over the last half decade. Without a Microsoft-style monopoly to automatically sell its software, Apple is forced to actually deliver a product that is good enough to convince the market to go out of its way to choose to buy it.

While Apple’s Mac OS X doesn’t generate direct licensing revenue, it does add value and differentiation to the company’s machines. Apple works hard to trumpet the retail interest in Mac OS X at every release, but the painful secret that Apple itself would never advertise is that its software sales are not incredibly profitable, particularly in comparison to its Mac hardware sales.

In the final quarter of last year, Apple brought in $9.6 billion, almost entirely from Mac and iPod hardware. It “only” earned $170 million from sales of Leopard in the final quarter; subsequent retail box OS sales quickly dropped down to $40 million in the next quarter of early 2008. Of course, pulling in those extra millions in software upgrades is a great bonus. However, Apple is not a software vendor; it is only making some extra cash on the side for the OS it develops primarily to sell its new hardware.

As Steve Jobs once observed, Apple’s OS sales are like “printing money.” Apple sells Mac OS X at retail only to help recoup the money it invests in developing it. If it were wildly profitable to sell the OS, Apple wouldn’t be silent on the issue of licensing Mac OS X to other hardware makers. Apple hasn’t even entertained the idea of licensing Mac OS X on systems in markets it does not compete in. Mac OS X exists to sell Macs.

That indicates that, outside of bragging rights, Apple doesn’t desperately need to work on delivering volume sales of Mac OS X at retail. Apple isn’t selling Mac OS X against Vista, it’s selling its Macs against Windows PCs. The only good reasons to lower the price of a product is to:

  • induce volume sales to broaden its installed base. Apple is doing this with the new $199 iPhone 3G, as Sony has been with its subsidized PlayStation 3. However, Mac OS X (and Snow Leopard in particular) has a finite market, so again, dropping the price would only cut into revenue dramatically while generating minimal additional sales. Anyone who really wants it is going to pay whatever reasonable price is being charged.
  • compete against direct or indirect rivals. Mac OS X has no direct rival. It has no indirect pricing pressure from Windows because nobody directly chooses one OS over the other in a shopping comparison. The retail price of Mac OS X does not add any cost to a new Mac versus a PC, and Windows considerably more expensive already anyway. Apple doesn’t have to deeply discount Snow Leopard to reach customers.

Why OS X is on the iPhone, but not the PC

3. Apple Would Rather You Buy A New Computer Than Give Away Mac OS X.
Most of Snow Leopard’s features announced so far exploit the potential of new and forthcoming hardware. The primary purpose of Mac OS X is to distinguish Mac hardware from PCs. Selling it at retail only helps Apple pull in some extra revenue from users who are not ready to buy new hardware.

There are two alternatives to buying a Mac OS X upgrade at retail: not upgrading at all, or buying a new Mac. Mac OS X retail sales only compete against users’ price sensitivity; it has to be priced cheap enough to sell users on buying it, because it is a largely optional purchase. Apple would happily sell users a new Mac rather than a Mac OS X upgrade. However, the company would just as happily sell full price Mac OS X upgrades to everyone it can, ensuring that those Mac users remain satisfied and more likely to buy a new Mac in the future.

Deferring a $2000 computer sale to sell a high margin $129 software product is not a problem. Delaying the potential purchase of a new Mac by offering a $20 upgrade that costs $10 to distribute makes no sense. While most people who are interested in buying a new computer aren’t going to delay their purchase just because they can buy the newest version of Mac OS X at retail, giving Snow Leopard away certainly wouldn’t help sell new Macs in the near term, and doing that at cost or at a loss would be ridiculous.

The last time Apple delivered a free reference release of Mac OS X was 10.1. That was a follow up to the original commercial debut, and mostly supplied missing features and stability fixes to help bring Mac OS X closer to parity with the classic Mac OS. Apple couldn’t sell it at full price because nobody was even using Mac OS X at the time beyond a small group of early adopters. The company desperately wanted to induce adoption by any means necessary, so giving away a substantial reference release of Mac OS X made sense.

It wasn’t until the following 10.2 Jaguar release that Mac OS X became Apple’s mainstream OS. It now makes no sense for Apple to give away its development work because it isn’t in the same desperate position. Mac users who aren’t going to upgrade unless the software is nearly free are not worth Apple’s attention. They are likely to just steal it anyway.

4. Apple Doesn’t Bother Trying to Sell to Thieves.
Apple sells Mac OS X just as it retails music: it markets both products toward premium buyers at reasonable prices rather than attempting to force thieves to pay for a product they only want to steal. Microsoft failed in the music business with Windows Media because it tried to do just the opposite: force everyone to pay through the nose for expiring subscription music by using egregious DRM. Microsoft couldn’t force the thieves to stop stealing, and premium customers weren’t interested in being treated like thieves.

Microsoft used that strategy because it has seemed to work well on the Windows PC desktop. However, that is entirely due to the company’s monopoly position. Consumers don’t have a choice in PC operating systems, and that lack of competition is reflected in Microsoft’s predatory pricing: it sets the retail price of Windows desktop upgrades between $200 to $500

Microsoft can set a high retail price because it knows most people will just get Windows unwittingly with new hardware; the company reports that 80% of its Windows revenues come from people buying new PCs with an OEM copy of Windows on it. Relatively few people ever buy Windows at retail, which is part of the reason why the Vista launch parties Microsoft attempted to throw simply fell flat.

Premium, price-insensitive users who need to buy a retail license will bite the bullet and spend whatever Microsoft charges. The company can also offer special deals to anyone that might be price sensitive, removing any pricing liquidity from the overall market. It’s nice work if you can get it. Microsoft got it in part through “first one is free” marketing that leveraged software piracy.

Throughout the 90s, Microsoft tolerated piracy of Windows because it helped the company achieve market dominance. Now that it holds an overwhelming monopoly on the PC operating system market, it has started policing its software licensing with online activation and its Windows Genuine Advantage spyware.

Apple’s smaller market means piracy doesn’t really benefit the company. Even so, it does not police Mac OS X licensing with DRM, activation procedures, or spyware because it only sells to premium customers rather than trying to tax the entire PC market. The majority of Microsoft’s customers are thieves that would only pay for Windows if they had no choice. Apple’s customers have voluntarily chosen to buy from the company; offering them regular advances at consistent prices allows the customer to decide if they want to upgrade or not.

Microsoft’s Plot to Kill QuickTime

5. Snow Leopard Will Be Worth More than $129 To Those Likely to Buy it.
The key benefit Apple has marketed in Snow Leopard so far is Exchange Server support. How much is that worth, and who would pay for it?

Microsoft charges Mac users $500 (a whopping $350 premium over the regular version) for the version of Office 2008 that includes support for Exchange. Why is Microsoft ripping off the customers who are using its own server software? Microsoft knows that the organizations who have chosen Exchange are not price sensitive. Those customers already pay absurd licensing costs for its server and client access licenses, so they are likely to also shell out crazy amounts of money for a slightly less awful version of the Entourage Mac email client.

If Microsoft can get away with charging businesses and education users $500 for Exchange support in Office 2008, Apple will have no problem selling those same customers an overhauled operating system that adds Exchange support for Mail, iCal and Address Book for just $129.

What about home users who have no need for Exchange? Outside of those that want to buy every new release, that segment of the market is unlikely to buy Snow Leopard. We know this because they largely didn’t pay for Leopard.

Road to Mac Office 2008: an introduction
Road to Mac Office 2008: Entourage ‘08 vs Mail 3.0 and iCal 3.0

Who Bought Leopard?
In 2009, Apple will have an opportunity to sell Snow Leopard for $129 to an installed base of around 23 million Intel Mac users. Dropping the price won’t make much of a difference in how many copies it sells because people who want or need it will pay $129. The real secret is that only a minority of Mac users actually upgrade at retail.

Consider the Leopard launch. Apple’s $170 million in Leopard revenues reported in its debut quarter is only enough to buy 1.3 million copies at retail price. A third – a surprisingly high percentage – of retail packages were family pack versions, meaning Apple actually sold fewer boxes than that at full price. Of course, lots of those retail boxes where sold to retailers at lower wholesale prices and then marked up by the retailer.

(Incidentally, Information Week’s Antone Gonsalves reported that Apple sold “170 million copies of Leopard,” which would be more than the number of Macintosh computers the company has sold over the past three decades. Several other sources repeated the same idea. “Operating systems traditionally sell very well the first quarter they are available, but then loose [sic] steam very quickly. Apple sold 170 million copies of Leopard in the first fiscal quarter, but that number dropped to 40 million last quarter, the CFO said.”)

Apple actually reported selling 2 million copies of Leopard in the first weekend. It did not continue to report how many additional copies it sold after that initial figure because Apple didn’t want to highlight the fact that most of the people who bought Mac OS X in the quarter did so over the first weekend. That weekend figure also probably included shipments to stores, further padding the number with marketing muscle.

More recently, the company indicated that of the 27.5 million installed base of Mac OS X users, 37% are running Leopard. That would be 10.1 million Macs running Leopard. Apple has sold roughly 4.6 million new Macs in the last three quarters with Leopard pre-installed. That means “only” 5.5 million Macs have been upgraded to Leopard.

But Apple didn’t earn something like $709 million by selling 5.5 million boxes for $129 or more. It only reported $210 million in total revenues in Leopard sales over first six months, and has sold less than $40 million worth of Leopard since then. That’s less than $250 million in total retail software sales. Clearly, a lot of retail boxes are getting applied on multiple Macs using the family pack or are simply being installed on multiple Macs contrary to the license agreement. Big surprise: lots of people are stealing Leopard.

So of the 27.5 million Macs that perhaps could be using Leopard, “only” 37% have been upgraded, and about half of those got Leopard by buying a new Mac. That’s great compared to the percentages of retail software upgrades for Windows, but indicates that setting a lowball price for Snow Leopard wouldn’t have a major impact on new sales; it would only leave money on the table that Apple could otherwise earn from a reasonable charge for its software work.

There’s another angle on the value of Snow Leopard: it’s not just an operating system. The next myth will take a look.

WWDC 2008: New in Mac OS X Snow Leopard
Myths of Snow Leopard 1: PowerPC Support — RoughlyDrafted Magazine
Myths of Snow Leopard 2: 32-bit Support
Myths of Snow Leopard 3: Mac Sidelined for iPhone
Myths of Snow Leopard 4: Exchange is the Only New Feature!
Myths of Snow Leopard 5: No Carbon!
Myths of Snow Leopard 6: Apple is Out of Ideas!
Myths of Snow Leopard 7: Free?!

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