The Apple iPod Phenomenon: Rebooting Coolness, Culture, and Commerce (Part 2 of 3)

. . . Continued from Part 1

3.0              Network Perspective

3.1       General

Network perspective is concerned with the understanding of the complex relationships between organisations or companies over a period of time to develop and attain competitive advantage.

In the analysis of Apple’s business network, we can identify that Apple possesses three subgroups or network clusters i.e. the cluster for the Mac personal computer line of business, iPod line of business, and iPhone line of business.  Each of the network clusters exhibit its own level of embeddedness.  For e.g., in the iPod line of business network cluster, Apple’s first relationship tie or link is to Cheng Uei Precision, whom Apple had thoroughly evaluated and appointed to manufacture/assemble the iPod.  With the increasing iPod demand over time, Apple appointed Ji-Haw Industrial as the second manufacturer/assembler (New iPod Maker, 2004).

In turn, Cheng Uei Precision and Ji-Haw Industrial have their respective subgroup network relationships albeit they may also share common parts or component suppliers, for e.g. Seagate, a hard disk drive manufacturer.  This network embeddedness is shown in Figure 3-1.

However, for e.g., the network embeddedness does not stop at Seagate, as Seagate will also possess its own subgroup network; and a company known as Komag – one of several manufacturers in the world of the magnetic discs used in hard disk drive manufacturing – would likely be present in Seagate’s subgroup network.

Figure 3-1: Apple’s Network Embeddedness

Furthermore, each tie of link in Apple’s network may exhibit a similar or variant relationship.  Figure 3-2 shows Apple’s network relationships.  Relationship lines drawn in thick orange colour represents strong network relationships between Apple and the partners.  Thin orange relationship lines indicate an arm’s length relationship between Apple and the partners, and the dotted orange relationship lines represent the relationships between Apple’s partners, or second level relationships.

Of significance is a blue coloured thick relationship line between Apple and the music labels and recording companies, such as BMG, EMI, Sony Music, Universal Music, and Warner Music.  The relationship is unique and was critical to Apple achieving a competitive advantage because Apple was the only company licensed by the music labels and recording companies to sell digital music encrypted in the Advanced Audio Coding (AAC) format with Digital Rights Management (DRM) technology to prevent or minimize music piracy.  Non-iPod users i.e. Mac personal computer users will require a free iTunes application to download and playback the AAC-DRM encrypted (or protected AAC) digital music on their Macs.  The DRM restrictions on digital music files were removed from January 2009 onwards after Apple reached an agreement with the major record labels.

The digital music is sold online by Apple on its iTunes music store http://www.apple.com/itunes/.  The iTunes music store began life in 2003 with an initial 200,000 music files available for download, and prices then was USD0.99 cents per song.  Today, typical prices are USD0.69, 0.99 and 1.29 per song.  Apple rebranded the iTunes music store to iTunes media store since it now also offers movies, audiobooks, iPod games, Podcasts, etc.  Since late 2006, the iTunes media store “accounts for 85 percent of the songs downloaded in the U.S. according to Nielsen Sound Scan figures … and the store is open in 21 countries, which the company estimates covers nearly 90 percent of the market for where music is downloaded legally” (Michaels & Moren, 2006).

Figure 3-2: Apple’s Network Relationships

3.2       Key observations of Apple’s network

3.2.1    Tie Modality

Is concerned about the network from the following aspects:

a)            Strength of the Connection

Apple’s network comprises of strong network relationships and arm’s length relationships.  Apple’s relationships with its manufacturers/assemblers, design houses, software developers, Apple and iTunes online stores are strong network relationships where the following interaction elements take place:

§         Trust – critical to establish strong embedded ties where the connected parties will not act to each other’s self-interest at the expense of the other

§         Fine-grained information transfer – is implicit and holistic in nature where important product and trade secrets are shared between the parties for critical mutual benefits

§         Joint problem-solving activities – the parties work closely to resolve operational, product and technological challenges, again for their critical mutual benefits

§         Risk taking and investment – with the above elements of trust, fine-grained information sharing and joint problem-solving relationship, the parties concerned are able and willing to take necessary business risks and investment needs within the network

§         Complex or adaptation – with all the above interaction elements, the parties in the network are able to adapt to new market challenges and opportunities

b)         Intent of the Connection

This is concerned with the parties of the network coming together for exploration or exploitation objectives.

In the case of Apple, the network it builds with its key partners, for e.g. the manufacturers/assemblers of its iPods, has an exploitation intention where Apple can leverage on the manufacturing and assembling expertise and infrastructure of companies like Cheng Uei Precision and Ji-Haw Industrial, without the need for high capital investments for manufacturing and assembly plants and facilities.

Similarly, Cheng Uei Precision and Ji-Haw Industrial are also exploiting Apple in the sense that by producing high demand Apple products such as the iPod, the business opportunity adds significantly to their company revenues and profitability, respectively.

In other relationships between Apple and its design house partners, the intent takes on an exploration relationship where both parties explore product, design and functionality innovations.

Outside of the United States, Apple adopts an arm’s length relationship with its distributor and dealer retail channels branded as Apple Centres.  After a certain period, non-performing distributors or dealers are replaced with more capable and committed ones – this is clearly an exploitation approach by Apple by being able to go to market quickly without high capital investments to establish its own retail stores in every major country or markets.

c)         Nature of the Connection

Nature of the connection questions the cooperation or competition aspects of the relationship.  For e.g., Apple can promote competition between its iPod manufacturer/assembler to attain a higher level of production quality and cost efficiency improvements in production methodologies i.e. operational management concepts such as zero defect and Lean Six Sigma best practices.

Among its distributor and dealer channels, Apple can leverage competition to outperform each other in sales and customer support quality.  However, Apple will need to exercise proper judgment in promoting competition among its network subgroups or clusters in order to continue maintaining the network equilibrium to optimize mutual benefits.

To this aspect, most of the relationship ties or links are cooperative in nature, so that Apple and its partners leverage on each others’ strengths and balance out weaknesses.

d)         Stability of the Network

In Apple’s network, our analysis has shown that there are strong network relationships and arm’s length relationships.  Both forms of relationships add to the stability and dynamism of Apple’s network.

In other words, the strong network relationships between Apple and its partners creates stability in the network, while the arm’s length relationships between Apple and other categories of partners which can be changed or replaced from time-to-time, such as distributors and dealers, creates the dynamism of the network.

3.2.2      Network Position

Apple’s position in the network can be considered from:

a)      Characteristics of the Position, deals with:

§         The role of the firm over other firms

§         Identity of other firms (direct or indirect)

§         Importance of the firm

§         Strength of relationship

b)      Power

§         Differences in power results in different network positions

§         The ability to influence the decisions or actions of others

§         Relationships are asymmetrical with respect to power

§         Power structures dictate the way the network operates and develops

c)      Positional advantage

§         Particular positions in the network can serve as a source of competitive advantage

§         Competitive advantage can only be achieved if a particular firm has at least 3 relationships with 3 other firms, and the position held is not too strong

Thus, Apple gains positional advantage from having strong network relationships from:

o       Specially selected partners that contribute different or complimentary functionalities and expertise

o       The music labels and recording companies providing Apple with exclusive distribution rights to AAC-DRM encoded digital music titles

o       Software developers which Apple collaborates with in developing ease-of-use and advanced technology firmware and operating systems

o       Apple is able to hold centre-court within its network, deciding on final product and service offerings, and business terms & conditions

o       Collaboration and inputs from its Level 2 network partners enable Apple to explore new ideas and technology via its Level 1 network partners

3.2.3        Legitimacy

Apple gains legitimacy through its network performance from the following key areas:

a)                  Economic

This concerns the economic returns or the creation of shareholder value through revenue generation and profitability.  As shown in Section 1.0 – Introduction, Apple’s financial or economic returns are very promising and profitable.

b)                  Legal

In the area of legality and as far as the iPod and the music industry is concerned, reducing and eradicating music piracy remains a challenge.  With the iPod and iTunes media store, Apple has been championing the use of original songs vis-à-vis upholding the intellectual property rights of singers and related parties.

Apple only promotes the sale of AAC-DRM encrypted digital songs on its online iTunes media store instead of the generic MP3 digital audio format.  Only from January 2009 onwards, Apple removed the DRM restrictions after having secured the agreements of the major records labels.  Thus, the initial AAC-DRM only music files gave Apple a market edge in gaining the confidence of the major record labels.

Furthermore, the AAC encoding technology has been standardized by the International Organisation for Standardization (ISO) and the International Electrotechnical Commission (IEC) as part of MPEG2 and MPEG4 standards (Herre & Dietz, 2008, pp. 137 – 142; Dimkovic, 2001, pp. 1 – 7).

c)                  Ethical

Apple practices and consistently champions the:

§         Use of legally obtained songs and downloads

§         Use of original software among its customers

§         Sales of original software by its distributor and dealer channels

3.2.4    Structural Hole

A structural hole (Burt, 1995) exists between the traditional music industry (using analog playback equipment, audio cassettes and CDs) and digital technology.

Apple was able to identify this structural hole and the opportunity it presented, and bridged the chasm with innovation on the consumer-side with the introduction of a highly portable, high audio reproduction quality, and cool-looking digital device called the Apple iPod, packaged with supporting services such as the availability of original digital songs at very affordable prices, and a cyberspace platform that provided 24x7 access to buy the digital songs.

For the traditional music industry plague with music piracy, declining sales, and changing consumer trends brought about by the Internet and digital technology, the new revenue channel opportunity presented by Apple was too good to ignore.

3.2.5        Network Effects

The Apple network has resulted in the following effects (some examples):

§         Created an unprecedented economic boom in the way people acquire, listen and manage their music libraries i.e. the iPod Generation

§         Apple has sold over 160 million units of iPods for the period 2001 to 2008 (Boffey, 2008)

§         The 100 millionth iPod was shipped in April 2007 (Cohen, 2007)

§         In the fiscal year 2006, Apple shipped 5.3 million units of Macs, but 39 million units of iPods (Michaels & Moren, 2006)

§         As of late 2006, the iTunes media store accounts for 85% of the songs downloaded in the United States, and is open to 21 countries, which is estimated to cover nearly 90% of the market for where music is downloaded legally (Michaels & Moren, 2006)

§         Apple reported a record profit for fiscal Q1 2009 (Dalrymple, Seff & Michaels, 2009)

As networks are heterogeneous, thus, the difficulty of duplicating the uniqueness of Apple’s network relationships, interactions, and advantages creates a competitive advantage for Apple Inc.

Continued in Part 3 . . .

The Apple iPod Phenomenon: Rebooting Coolness, Culture, and Commerce (Part 1 of 3)

Abstract

The field of strategic management has been around since the 1960s when the Design School first presented the basic framework which focuses on strategy formation as a process of conception.  Fast forward to now, the 21st century, where with the Internet and advances in information and communication technologies and infrastructure, the world has become “smaller”.  The multi-national corporations’ continuous drive to create wealth from scarce resources reaches out further – an economic phenomenon known as globalisation.  Global and virtual markets are created, and competition and competitiveness continues to be a major challenge to many companies and corporations.  As today’s markets have become increasingly more complex and dynamic, the need to effectively evaluate, formulate and execute strategies built upon the firm’s resources and core competencies require a more sophisticated approach i.e. a multi-perspective approach to strategy.  This paper attempts to explain strategic management from a multi-perspective approach using Apple’s tremendous success with the iPod as the basis of the discussion of how Apple gained competitive advantage over its competitors although it lacked the first mover advantage with the iPod.

1.0           Introduction

Since it’s founding on April 1, 1976 as Apple Computer Co. by Steve Jobs and Stephen Wozniak, Apple Inc. had always sought to do things differently.  The “Think Different” slogan and advertisement campaign from 1997 to 2002 was Apple’s immensely successful and long-lived marketing campaign (Hormby, 2007) because the concept personified what Apple is in the eyes of both its loyal and potential customers when compared to traditional computer giants such as IBM and Hewlett-Packard, then and even today.

Apple was voted by BusinessWeek as the most innovative company five years in a row – 2005 to 2009 (World’s Most Innovative, 2007; World’s Most Innovative, 2009a).  Fortune voted Apple as the world’s most admired company for 2008 and 2009 (Fortune: World’s Most, 2009).  Fast Company voted Apple in 2008 as the world’s second most innovative company, and for 2009, the world’s fourth most innovative company (World’s Most Innovative, 2009b).

In 1984, Apple gave us the highly innovative Macintosh or Mac personal computers with its outstanding and industry leading graphical user interface (GUI)-based Mac operating systems.  Apple was also the first to introduce the use of the mouse with a personal computer in 1983.  (See Figures 1-1 and 1-2).

Figure 1-1: Pre-1984 Apple Personal Computers

Figure 1-2: Post-1984 Apple Personal Computers

Apple did not limit their vision and creativity to personal computers only, and in 2001 introduced the iPod, and followed by the iPhone in 2007.  Since then, both the iPod and iPhone have gained significant market share from competitors, created market niche, and continue to build loyal customers throughout the world.  The introduction of the iPod also created the “iPod Generation” culture of digital music entertainment that redefined the economics of acquiring, managing, sharing and enjoying music.  (See Figure 1-3).

Figure 1-3: Apple iPods and iPhones

The Apple iPod – a relatively simple device to enable the storage and playback of digital music files – was not the first portable digital music player (a.k.a. MP3 player) to be introduced to the world at large.  In the late spring of 1998, a Korean company known as Saehan had launch the MPMan, and it was sold in the United States in two variants by Eiger Labs under the names Eiger Labs MPMan F10 and F20 (Buskirk, 2005).  A few months later, another United States company known as Diamond Multimedia launched the Diamond Rio PMP300, and was soon joined by many other companies around the world including the consumer electronic giants Sony, Samsung, and Panasonic.

Today, Apple’s nearest competitor is Creative Technology Ltd, a Singapore company, who had launched the world’s first hard drive-based digital music player – the Creative Nomad Jukebox in 2000 – a year earlier than Apple iPod!  However, as at April 2007, Apple had sold 100 million units of iPods versus Creative Technology’s 25 million units as at November 2007 (Cohen, 2007; Creative reaches, 2007).  The following Figures 1-4 and 1-5 shows Apple iPod sales statistics.

Figure1-4: Cumulative Sales (units) of iPods by Fiscal Quarter

Source: Wikipedia - iPod

From the above Figure 1-4, iPod cumulative sales reached 50 million units by the second fiscal quarter of 2006, and 100 million units by the second fiscal quarter of 2007, and over 160 million units by the third fiscal quarter of 2008.

Figure 1-5: Sales (units) of iPod per Fiscal Quarter

Source: Wikipedia - iPod

Figure 1-6: Sales (units) of iPod upto Fiscal Q1 2011

Source: Wikipedia - iPod

For Apple’s fiscal 2009 second quarter i.e. the quarter ended March 2009, amidst the global financial turmoil, Apple reported an increase in revenue by 8.7 percent to USD 8.16 billion on strong sales of iPhones and iPods, compared to USD 7.51 billion a year ago.  The USD 8.16 billion revenue beat Wall Street’s average forecast of USD 7.96 billion.  Gross Margin increased by 20 percent to USD 2.97 billion compared to USD 2.47 billion a year ago, and Net Profit increased to USD 1.21 billion compared to USD 1.05 billion a year ago (iPhone and iPod, 2009, p. B10). The following Tables 1-1 and 1-2 shows the financial performance of Apple.

The earnings per share for the fiscal quarter ended March 2009 was USD 1.84, well above the USD 1.09 forecasted by Wall Street.  For the reported quarter, Apple shipped 2.2 million Mac personal computers – a reduction by 3 percent from a year ago; shipped 11 million iPods (launched in 2001) – an increase by 3 percent from a year ago, and an increase by 123 percent for iPhones (launched in 2007) to 3.8 million units shipped (Strong iPhone sales, 2009, p.  B13).

Peter Oppenheimer, CFO and Senior VP, said, “I think in a better economy our sales certainly would have been higher but … we have just reported the best non-holiday quarter in Apple’s history despite the economy that we find ourselves in” (iPhone and iPod, 2009, p. B10).How did Apple achieve so much success with the iPod? How did Apple outmanoeuvre the competition? This paper will attempt to explain the iPod phenomenon from three strategic management perspectives i.e. Industrial Organisation Economics, Network, and Entrepreneurship.

2.0           Industrial Organisation Economics Perspective

2.1          General

Industrial Organisation Economics (IO) perspective deals with the theory and explanation of the behaviour of firms, as a legal entity and within their respective industry groups.  In other words, how firms develop and grow.  The key concepts of IO perspective concerns imperfect markets: market structure, market performance, and market power.

The market structure determines the market performance, and the firm in the market with a larger market share possesses a stronger market power.  In other words, the firm can control or influence price, and thus, able to shift demand.  Let us now apply the key concepts of IO perspective to the Apple iPod phenomenon.

IO perspective largely focuses on the market or industry structure, or the attractiveness of the industry in terms of industry rivalry, entry barriers, relationships with buyers and suppliers, and product and/or service substitutes – Porter’s Five Forces (See Figure 2-1) (Porter, 2008, pp. 78 – 93).

One of the major developments of IO was derived from the Structure-Conduct-Performance (SCP) paradigm or model which focuses on the market or industry and not the firm (Rickard, 2007, p. 71).

Figure 2-1: Porter's Five Forces

2.2              Market Structure

In the Apple iPod case, the music industry in the period 1999 to 2000 was still in the analog technology era and oblivious to advancements in digital information and communication technologies brought about by the Internet boom.  Apple recognized the “structural hole” (Burt, 1995) in the market structure and the opportunities it presented in terms of the potential market performance.

2.3              Market Power

A firm with market power possesses the ability to alter or determine market prices.  The larger the firm’s market share, the larger or stronger its market power.  The market structure often acts as a guide to market power, for e.g. in the highly regulated oil and gas industry, the Organization of the Petroleum Exporting Countries (OPEC) – an intergovernmental organisation representing thirteen oil producing nations possess strong market power.  However, there exists opposing forces to market power of firms as shown in Figure 2-2.

Figure 2-2: Market Power - Firm vs. Society

How is Apple able to price their range of iPods much higher than its competitors since the very beginning of the iPod launch in 2001 when they entered the market after its competitors?  How did Apple managed to continue to dictate pricing and yet win so many iPod sales to become the world’s biggest supplier in the digital music player product category, ahead of its closest rival by a 400 percent lead in 2007? (Cohen, 2007; Creative reaches, 2007).  The answers lie in how Apple acquires and maintain its market power.

In the iPod line of business, Apple acquires market power from:

§         Legal protection and Strategic alliances

Apple champions the copyright interests of the music labels and recording companies, and the singers or artists they represent.  To prevent or minimize the risk of music piracy, Apple uses the Advanced Audio Coding – Digital Rights Management (AAC-DRM) encryption technology to ensure that music purchased and downloaded from its online store iTunes can only be played back on iPods (and Mac personal computers via an iTunes application).  Additionally, the music labels and recording companies authorize Apple as the sole supplier of AAC-DRM encrypted songs for the iPod.

§         Product differentiation

Apple, well-known for its innovation, is able to design a super-cool product with ease of use, and further differentiate the product by various form factors and functionality such as the miniature iPod Shuffle and iPod Video models.

§         Advertising and Marketing

Apple’s advertising approach and marketing campaigns have always featured user or human lifestyles, creating psychological images of style, cool & hip, and satisfaction – never on the product and its technical specifications.

Apple maintains its market power from:

§         Vertical relations

Through the market structure, Apple configures its distributor and dealer channels with the “Apple Centre” identity and the channel partners become the sole retail source for Apple products.  In this way, Apple regulates the seller – buyer interaction at the point-of-sale to ensure and enforce a high quality customer interaction associated with the “Apple Centre” identity.

§         Reputation

Apple possesses a very positive reputation in its innovativeness and technological leadership in design, functionality and usability of its products and in the subtle creation of the “Apple lifestyle”, for e.g. with the iPod, Apple has created the iPod Generation.

Therefore, the ability of Apple to be in sync with the market or external environment enables it to quickly identify market structure opportunities.  Its ability to utilize its resources to build strategic alliances, to innovate, to differentiate and effectively position its products against its competitors in order to acquire market power gives Apple the competitive advantage to shift and manage demand.

Continued in Part 2 . . .