Daniel Eran Dilger in San Francisco
Random header image... Refresh for more!

Apple is gaining power because of profits

Daniel Eran Dilger

Ready to be blown away by an epiphany of the obvious? All of the talk over the last 20 years about how “delivering innovation” was the factor selecting success in the tech world was wrong. Here’s why.
.
.

Back in the late 70s when personal computing was just sprouting, Apple was a leading star with its Apple II line. It then was broadsided by IBM’s PC in 1982, followed by a bold effort to take back its former position with the 1984 Macintosh. A decade later, Microsoft’s Windows 95 essentially knocked Apple out for the rest of the 90s until the company came fighting back with the iPod, iPhone and iPad, rapidly retaking the position as the leading maker of personal electronics.

If you hear people talk about why Apple went up or down or back up again, or why IBM or Microsoft or anyone else has gained ground, it always gets associated with “innovation,” a fancy way of saying “new.” They thought up new stuff and that allowed them to take back ground. But this really isn’t the case.

It all comes down to whether companies could profitably monetize the new things they were making. Innovation is necessary, the same way “effort” and “operational management” are necessary. But there’s nothing about hard work that guarantees success unless that hard work can be translated into profitability (at least when success is defined in terms of dollars, which it is in business).

Dollars are just a currency for the idea of being able to do something. So having money literally means having power. And today, Apple has over $100 billion of ability to do things.

Consider the IBM PC and Windows

When Apple clashed with IBM PC in 1982, the question wasn’t whether IBM’s PC was more innovative. It clearly wasn’t on any technical level, having been designed by IBM to avoid competition with its other, established lines of business.

There wasn’t any key operational innovation going on, as IBM wasn’t hitting much lower price points (something the PC cloners later did achieve) or building PCs using innovation in manufacturing practices that Apple lacked. IBM’s margins were similar to Apple’s, it just had a bigger market.

IBM gained ground over Apple’s early computing products because it changed the target market from an early adopter business to a small segment of the established, mature market for business machines. IBM could afford to make nothing on PCs for some time, starving Apple of profits.

But it wasn’t IBM that ended up taking advantage of this market dominating leverage; it was Microsoft (through software licensing, taxing the new PC market) and PC cloners (introducing operational efficiencies that made their PCs much less expensive and/or more profitable than IBM’s).

Microsoft suddenly began reaping a huge percentage of the PC market’s profits, and could use these vast revenues to set up contracts that effectively blocked competitors out of the market. PC cloners fought amongst themselves, partnered with Microsoft, and struggled to make enough profit to have a voice in where the PC was going.

Apple lost ground. IBM lost ground, PC cloners lost ground (and merged together, or went out of business), and Microsoft invested its profits in creating a new products that helped entrench its position (Office, Server). Microsoft’s power just kept growing, because of its profitability.

Apple was innovating, if not one of the top innovating companies of the 1980s and early 1990s. Apple’s engineers invented QuickTime video for Macs at a time when PCs couldn’t play back audio reliably. There were plans in place to put the Mac interface on UNIX, and in the parallel universe of Steve Jobs’ NeXT, Apple-style innovation continued among a lot of ex-Apple engineers.

Compared to the progress of innovation between Apple and NeXT, Microsoft was leading the world backward. However, neither Apple nor NeXT are thought of as having much impact on the direction of technology from 1990 onward. So no, it’s not innovation that puts you in the driver’s seat. It’s profitability.

Microsoft was generating vast profits on software licensing. NeXT wasn’t able to sell much of anything. Apple was remaining profitable but not on the scale of growth that Microsoft had achieved. So Microsoft got to lead the world though the 1990s, and what a boring trip that was. The only people impressed with Microsoft’s technical deliverables were people who dismissed (or weren’t familiar with) the advances that had already been delivered in the 1980s.

Consider the Macintosh

The desktop software Microsoft delivered throughout the 1990s should have made Apple’s Macintosh look archaic, the same way today’s HDTV panels make those big tube TV from just ten years ago look ancient. Instead, Windows 95 inspired a sad nostalgia for the well constructed, intuitive, nice looking designs Apple had produced more than a decade prior. Microsoft’s Samsung Q tablet similarly made the decade-old Newton MessagePad look superior.

Now compare the Macintosh with Xerox Alto: the Alto felt like a huge generational leap backward, despite being developed to cost ten times as much as the Mac. And it was only about half a decade old when then Macintosh shipped. Every new version of the Mac System Software pushed it ahead, up until 1990.

In the 1990s, System 7 ambled along with no clear innovation, even though millions were being invested within Apple to update things. But Apple didn’t fall behind the curve because it wasn’t innovating enough, particularly compared to Microsoft. Apple fell behind because it wasn’t making enough money, and because it wasn’t enriching others to help it succeed.

Microsoft was not only making tons of money on licensing its own software, but was also creating a world around the PC where computer and peripheral manufacturers, software developers, trainers and support technicians were all earning money (the only reason Microsoft had lovers at all). This, not any leadership in “innovation,” was what propelled Microsoft to the leadership role in the 1990s.

Consider the iPod

Jump ahead one decade and you have Microsoft producing the Xbox and Apple introducing its iPod. The Xbox was never directly profitable, but it did enrich lots of peripheral developers and studios. But the iPod was directly profitable from the start. Both involved some innovation, although in reality, both were clever packaging of minimal technology that let users do a simple task that had been done before (if not as well).

Apple’s direct profitability with the iPod enabled the company to do things that all of its innovation (including the acquisition of NeXT and the development of Mac OS X) had not accomplished. Without the iPod, Apple simply wouldn’t have had the money to keep working on other innovations. More importantly, the iPod also gave Apple a peripheral ecosystem of partners who benefitted from its success.

Apple’s iTunes, like Microsoft’s Xbox, has never been dramatically profitable. Instead, Apple uses iTunes (and its App Store and iBooks children) to foster a peripheral moat of support from third parties. Like Microsoft’s Xbox, Apple’s iTunes is paid for by other successes. Unlike the Xbox, Apple has used its not-for-profit hub of iTunes to spin off highly profitable hardware: a decade of new iPod models, five generations of iPhone, and of course, those three iPads.

Apple has certainly cranked out a lot of innovations, but it’s the focus on profitability that has enabled the company to do that. One could try to argue that innovation and profitability are two sides of the same coin, but that’s not really true. Microsoft was very profitable without delivering much real innovation, and there are lots of innovative companies and groups that never see the light of day, or wilt in the sun like the WebOS group at Palm, simply because they can’t generate profits fast enough.

While there are lots of brilliant startups that have realized that a good idea and great work are no match for actually being able to make money. I can’t think of any examples of companies that are making money hand-over-fist who are really worried about how much “innovation” they have delivered in doing so, however.

What’s the point, Dan?

When you see tech pundits comparing Apple’s iOS with Android, for example, ask yourself, is this really about innovation? Google has delivered a series of new features for Android, some of which were immediately adopted by other platforms, and some of which are still unique to Android.

But Google isn’t earning money on Android. And even worse, most of Google’s licensees aren’t earning money on Android. Samsung is the primary successful Android licensee, and that success isn’t related to Android as much as Samsung’s ability to copy Apple’s designs and translate that into earning money.

Windows Phone 7 hasn’t earned money for Microsoft, and isn’t earning money for its licensees. One doesn’t have to contemplate how much innovation has occured. The fact that it is so well positioned on an operation level (with major partners, no deployment constraints) indicates that Microsoft’s problem isn’t in “delivering innovation” but rather in delivering a product that has the potential to make money. Microsoft’s partners are doing far worse than Microsoft itself. That’s not good.

Also, keep in mind that, from 1997-2002, Steve Jobs took Apple’s abysmal System 7 and turned it into several versions of Mac OS 8 and 9 that he was able to sell (after a decade of Apple’s struggling efforts to get anyone to pay for retail boxes of Mac OS software). There wasn’t a lot of pure innovation going on there, as much as productizing and marketing existing technology. Jobs clearly led Apple back to innovating, but the path to get there required profitability.

So you have pundits wringing their hands worried about whether Apple will be displaced by a sudden surge of interest behind Windows 8/Surface/Windows Phone 8 and/or Android. This seems a lot like worrying that a washed up old IBM, incapable of delivering competitive PCs, would knock the juggernaut of Windows 95 out of the water in 1996 with a product like OS/2 Warp. Are you kidding?

Apple controls the industry because of its profits. The sign that Apple has lost its control will be when some other company comes up with highly profitable products that are either cheaper/better smartphones/tablets/PCs, or neighboring devices that compete for customer’s money (the way the iPod’s profitability empowered Apple into the lead in other areas) or distantly peripheral products and services that have the potential to replace the hardware business Apple has built (the way the iPad snuck up and stole the PC business away).

Apple’s earnings today should provide some clue as to whether anyone is sneaking in an stealing away its leadership role. Because when it comes down to leadership in the tech industry, the company with the gold (not the fancy futurist videos about their innovation plans) makes the rules.

17 comments

1 DesDizzy { 07.24.12 at 5:29 pm }

Interesting thesis, only problem is you put the cart before the horse! You can’t just make money without producing a product that satisfy’s a need. This is often not “just” innovation, although innovation may be a part of it, it is more often delivering a solution. Whether the solution is simplicity, as in iPod or a “standard” as in MSDos/word/excel. One of the most important things for consumer success is that it is a standard or near standard or will become a standard.

2 Arnold Ziffel { 07.24.12 at 7:50 pm }

Dan,

You really know how to separate the wheat from the chaff. Thanks for clear-minded analysis of the tech world, especially that which relates to Apple.

3 jmfree { 07.24.12 at 8:09 pm }

Great insights, as always.

But I contend that profitability is merely symptomatic, and not the driver or “essence”, of innovation.

I once heard someone from the MIT Sloan School say something intelligent. It had to do with the difference between “invention” and “innovation”. He said an invention becomes innovation when it becomes widely adopted and useful.

In this sense, Linux and Wikipedia are innovations, whereas jet packs and Google Wave are not.

So, adoption is everything. Profitability may or may not follow, but either way an innovation is something new that large percentages of people eventually find useful because it “fits” a problem, it removes a limitation, and this adoption is sustainable.

But inventions can be taken by others and converted into innovations. Perhaps some tweaking happens in between. In the case of Windows, Microsoft stole 90%+ of the visual UI conventions developed by Apple (from “Pirates of Silicon Valley”: ‘Make it more like the Mac!!’ — Bill Gates), who was also as inspired by Xerox.

You allude to a key aspect of the Gates/Microsoft genius: “[Microsoft] was also creating a world around the PC where computer and peripheral manufacturers, software developers, trainers and support technicians were all earning money…”

This was the technique of promoting adoption, adoption by the earliest of early adopters: tech business partners. And Microsoft did a bang-up job with this, gained huge profits, spread them as little as possible (but just enough), and as we know abused its resulting dominant 90% market share position to the point of coming within a hair of being broken up by federal antitrust authorities.

Today we have Google, et. al. stealing 90%+ of the visual UI conventions developed by Apple, and now trying to give it all away to dozens of uncooperative partners, all in a desperate bid to generate sheer numbers in the adoption game. Arguably, the resulting experience is kind of sucky for the end user, and the 400+ hardware / software variants are a bit of a problem for those developing apps they hope consumers might actually pay for. (Fat chance.)

But, back to your original point: if the rip-offs aren’t clever enough to find a way for their partners to make money, the “adoption” will prove to be a fad and then convert to abandonment, on the scale of Netscape or Pet Rocks.

Unfortunately for all of the rip-offs at this moment in tech history, they just don’t seem to have the combined mojo of hardware, software, developer ecosystem, and retail presence even approaching that which Apple has made appear, like a rabbit out of a hat, over the last ten years.

So, Mr. DED, this is all by way of saying that once again you have it right. But, in this case, I think there is even more to the story.

PLEASE continue! I apologize for the interruption.

4 danieleran { 07.24.12 at 8:26 pm }

@jmfree: “profitability is merely symptomatic, and not the driver or “essence”, of innovation.”

Absolutely! My intent was to draw a distinction between “great ideas” (or perhaps products) and successful ideas/products. The difference is profitability. And the difference of whether something is profitable or not is not minor. It is monumental, the difference between whether something is sustainable or just a flash in the pan that can be trampled over by lessor ideas/products that can turn a profit.

And this also explains why Apple works so hard to say “no” to products that could be noodled along as Apple TV-like hobbies if it weren’t so intent on making only a) products that make profits and b) ecosystems that support those products.

Apple doesn’t make money on iTunes, nor the App Store, nor iWork/iLife, nor podcasting/iTunes U, nor iCloud, but all those things add significant value to iOS and Mac devices that make significant money.

If you look at the products Microsoft and Google are losing money on (say, Bing or Zune or WP7, or projects like Wave, Buzz, Google+ and Nexus 7 and Q), they SHOULD be making money! There’s no reason to be selling hardware that’s not going to make money. And there’s not really any sense in pushing out service that don’t contribute to other profitable businesses. But MSFT and GOOG are acting like they’re Apple in 1992, and spinning off all these unprofitable ideas that have no clear benefit to their other businesses. They’re just taking up resources and distracting them from focusing on delivering real, sustainable products.

And once you start rationalizing the in-house development of profitless, largely worthless projects, you can make excuses for acquiring pretty worthless subsidiaries for billions of dollars.

5 kent { 07.25.12 at 3:32 am }

Another stellar post, very much needed, particularly today. Apple yesterday reported earnings which beat its guidance, but came in under the “expectations” of Wall Street analysts, and so today there is glee and fear and loathing, all among the many who dislike Apple for its success, and its profits. I look at the basics – Apple beat its own publicly announced expectation. And in an economy in which Microsoft just announced its first ever quarterly loss and other companies are losing money. Apple added $7 billion in cash to its bottom line in a quarter when iPhone sales were down due to the soon to occur product refresh.

But back to the article. It is much needed for the general public to understand that profits are what fuel new products and services. It is refreshing to hear profits described as the positive force that they are in a time when they normally are described as almost evil, particularly by certain parts of the political class. It is good that Apple has generated profits, as these are the proof that their investment in people and new ideas were done right. Profit is the reward for virtuous behavior in the market and it is how the cycle is then continued again, with the company that met the market need and thus profited, having the capital to do the next thing. This is goodness, and Apple is justly being rewarded for its long term commitment to delivering value in the market. This article, and the accurate and honest portrayal of how profits are good, is incredibly important now, for all of us to understand if we are to build a strong economy. Thank you Daniel. Two excellent, insightful articles in the same week at a quality level that can’t be found elsewhere in the tech blogosphere.

6 tundraboy { 07.25.12 at 5:34 am }

“Apple controls the industry because of its profits.”

I would say it’s the converse that holds true: Because Apple controls the industry, it is able to make a lot of profit. (Although even with control profits are easily dissipated if they waste their money elsewhere.)

But the rest of your paragraph after the sentence I quoted, as well as your comment in reply to jmfree, indicates that you really meant the converse. But this isn’t a course in formal logic, so no real harm done.

7 tundraboy { 07.25.12 at 5:46 am }

I would add that the reason the PC eclipsed the Apple// and the Mac is easily explained in three letters: I, B & M.

In the early 80′s, the Apple brand doesn’t have the gravitas it carries now. It was a young company started by two young guys, the louder one of whom looked and sounded very much like an Acid-dropping hippie. No corporation in America was going to build its desktop computing infrastructure on such a company, especially if mighty IBM was selling a perfectly workable alternative.

8 JohnWatkins { 07.25.12 at 9:42 am }

Innovation is creating something more useful than the alternatives and that fits into users’ lives better. The result is a desirable offering which has enhanced value to the user. Value is key, as it correlates directly to what users will pay for the product. An often overlooked aspect of making an innovative, desirable product is making money from it. No product is innovative if it doesn’t provide a return to the producer.

If the product is innovative and has value, it entails IP which can be protected, which further entrenches it’s value. This value advantage allows the producer to command a superior profit margin, which makes the product sustainable for the producer. Apple is very focused at achieving this state. They make their products to please their users, but they are smart enough to know that they can’t produce those products unless they can reach that sustainability threshold.

There are a lot of products market that cannot hit any of those marks (useful, innovative, valuable, sustainable) but none of them are made by Apple.

9 gus2000 { 07.26.12 at 12:50 am }

Profits?!?? Some big-city Socialist YOU are. Sheez.

From reading the blogosphere, you would think that the only Apple innovation responsible for their huge profits is clever marketing. We’re all Apple Sheep! We buy anything shiny!

10 RNKLN { 07.26.12 at 2:40 am }

Great article, Dan, and it’s good to see you being active again on roughlydrafted.com

11 hblaschka { 07.26.12 at 4:19 am }

Building up on that MIT Sloan argument by jmfree above:

Inventions are waterdrops falling into a small pond
Innovations are waves on a lake
Profitability is surfing a Tsunami over the sea

One might (and probably will) someday fall off that killer wave, but probably had a hell of a ride.

It’s profitablity (plus that special culture needed) that keeps companies innovating (if at all, see below), until they loose their feeling for the wave and therefore profitability.

As simple as that: Microsoft (under Bill Gates) has proven that you do not need to innovate (all by) yourself to generate a wave, ifyou have enough profitability (in other areas) to afford to steal and combine inventions from others.

But hey, that’s what Steve did, too (from Xerox Parc).
“Good Artists Copy, Great Artists Steal.”
“It’s more fun to be a pirate than to join the navy. “

12 gctwnl { 07.26.12 at 12:51 pm }

Another great post, Dan.

Did you ever read “The Road Ahead” by Bill Gates (ghostwritten probably)? Published around 1998, I think. I found it illuminating, because in it Bill gives his own account of how Microsoft become successful (I recall that their initial strategy was called “riding the dragon”, where IBM was the dragon of course – whatever you do, don’t get thrown off). It also shows so clearly how poor a technologist he actually was and how completely unsuccessful at understanding what people need/want.

13 airmanchairman { 07.26.12 at 3:37 pm }

Refreshingly profound, incisive stuff, including the comments.

It makes one realize all of a sudden, my my, how pedestrian and sadly misinformed the blogosphere in general has become in recent times, at a time when clarity of vision and purpose is needed most.

14 The Mad Hatter { 07.26.12 at 5:56 pm }

Ready to be blown away by an epiphany of the obvious? All of the talk over the last 20 years about how “delivering innovation” was the factor selecting success in the tech world was wrong. Here’s why.

You forgot to include marketing. It doesn’t matter how good your product is, or how much money you have if you don’t get the message to the buyer.

Wayne
http://madhatter.ca

15 gavrojames { 07.26.12 at 6:18 pm }

@tundraboy

he absolutely did NOT mean the converse is true. how do you get power w/o profits? he’s saying alone, innovation doesn’t give you power.

16 The Mad Hatter { 07.27.12 at 10:09 am }

And here’s part of the reason Apple is making profits:

http://news.cnet.com/8301-1023_3-57480255-93/jonathan-schwartz-oracle-bungled-its-chance-at-mobile-java/?tag=mncol

Jonathan Schwartz, who used to be the CEO of Sun Microsystems, and arranged its sale to Oracle, is buying only Apple hardware for his new startup.

If you watch TV, the current seasons of many shows, including Law & Order SVU, and Criminal Minds, are using Apple hardware.

Someone at Apple did one heck of a good job in Hollywood.

Wayne
htttp://madhatter.ca

17 kovacm { 07.30.12 at 5:52 am }

“So no, it’s not innovation that puts you in the driver’s seat. It’s profitability.”

true, true…!
just like Atari in 1985: ST was far better technical/more innovative than Mac but Apple manage to make more money on Mac than Atari on ST …

You must log in to post a comment.