Design Quality and Customer Delight as Sustainable Advantages

Wednesday, 9 October 2013

I’ve been thinking about this piece by Ben Thompson, “What Clayton Christensen Got Wrong in His Theory of Low-End Disruption”, since he published it two weeks ago.

The business buyer, famously, does not care about the user experience. They are not the user, and so items that change how a product feels or that eliminate small annoyances simply don’t make it into their rational decision making process.

Again, though, Christensen’s research is tilted towards business buyers. Critically, this includes the PC. For the most of its history, the vast majority of PC purchasers have been businesses, who have bought PCs on speeds, feeds, and ultimately, price. […]

The attribute most valued by consumers, assuming a product is at least in the general vicinity of a need, is ease-of-use. It’s not the only one — again, doing a job-that-needs-done is most important — but all things being equal, consumers prefer a superior user experience.

What is interesting about this attribute is that it is impossible to overshoot.

In a sense, there are two rational Apple bear arguments. The first is that it doesn’t matter whether Apple can create superior products and experiences — the low-end competitors will eventually reach a “good enough” point that will disrupt Apple’s business. I think Thompson has made a good argument in this piece that such logic does not pertain to consumer markets, especially ones where fashion, style, and design are important attributes. Cell phones have always been about fashion and design.

The automobile industry analogy has forever been used in arguments about Apple, but I think that’s because in a broad sense it’s quite apt. Cars are an established, century-old market. There have been periods of low-end Clayton Christensen-style disruption — the Japanese imports in the ’70s and ’80s and corresponding collapse of Ford, GM, and Chrysler’s collective market dominance is a good example. But it is undeniably true that there is a sustainable and profitable high-end of the market, occupied by companies like BMW, Mercedes-Benz, and Porsche. Point this out and someone will inevitably argue that sure, those companies are thriving, but they all have tiny market share. But Apple is sort of like BMW, Mercedes, Porsche, and Lexus all rolled into one. There just aren’t that many competitors for this segment of the market in phones and tablets, and most of them aren’t very good.

Thompson really puts this well:

The issue I have with this analysis of vertical integration — and this is exactly what I was taught at business school — is that the only considered costs are financial. But there are other, more difficult to quantify costs. Modularization incurs costs in the design and experience of using products that cannot be overcome, yet cannot be measured. Business buyers — and the analysts who study them — simply ignore them, but consumers don’t. Some consumers inherently know and value quality, look-and-feel, and attention to detail, and are willing to pay a premium that far exceeds the financial costs of being vertically integrated.

How do you quantify delight?

The second Apple bear argument comes from those who think Apple has already lost its design and experience advantage — that devices from Samsung, Amazon, Google and whoever else have already equalled or surpassed Apple’s, and at lower prices to boot. To these critics, the nine million people who bought new iPhones in its first weekend simply haven’t woken up yet. Me? I think this second group is wrong about the state of Apple’s design advantages. (Shocking, right?) But I think they’re correct about Apple’s strategic needs. The only way Apple can continue to succeed is the same way they have succeeded for the last 30 years: by producing superior products and experiences to their competitors.

So, as I see it, the first group of Apple bears is wrong about whether design quality can create a sustainable advantage in the phone and tablet markets. The second group is wrong about whether Apple’s products even are superior in design to those of its competitors. These are very different arguments, and largely at odds with each other. But in broad strokes, many of those who are prone to view Apple’s prospects in a negative light — those who, in Horace Dediu’s apt description, view Apple “as a company that is in a perpetual state of free-fall” — lump these two divergent schools of Apple bearism together under the loose umbrella argument that Samsung, LG, et al are going to be the death of the iPhone and iPad. Significant market share for any Android devices is seen — by these observers — as proof of either or both schools of Apple bearism.

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There is a third school of Apple bears, whose philosophy is perhaps best and almost certainly most-frequently espoused by Henry Blodget. This school holds, more or less, that while design quality may allow for a sustainable advantage in some fields, it does not for software platforms. That once one software platform achieves a large majority market share, developers will inevitably flock to that platform, no matter if it’s technically and/or aesthetically inferior, based on market share alone. I.e. BMW can thrive because its cars consume the same gas and drive on the same roads as every other car on the road, but the iPhone will inevitably shrivel as developers abandon it for Android.

Here’s Blodget, in his own words, just last month, “Apple Is Being Shortsighted — And This Could Clobber The Company”:

If smartphones and tablets were not a platform — if the only thing that mattered to the value of the product and a customer’s purchase decision was the gadget itself — then Apple’s loss of market share would not make a difference. Apple zealots would be correct when they smugly assert that what matters is Apple’s “profit share” not “market share.”

But smartphones and tablets are a platform.

Third-party companies are building apps and services to run on smartphone and tablet platforms.

These apps and services, in turn, are making the platforms more valuable.

Consumers are standardizing their lives around the apps and services that run on smartphone and tablet platforms.

Because of these “network effects,” in platform markets, dominant market share is huge competitive advantage.

In platform markets, as the often-hated but always insanely powerful Microsoft demonstrated for decades in the PC market, the vast majority of the power and profits eventually accrue to the market-share leader.

Put another way, this third strain of Apple bear subscribes to the theory that iOS is the new Mac, Android is the new Windows, and Apple is about to see the 1990s all over again.

I agree with Blodget in one regard: the Mac, and its decades-long competition against Windows and the commodity PC industry, serves as a useful example. But I disagree what the Mac proves.

What I see with the Mac is a platform whose darkest hours were not the result of minority market share, but rather coincided with a loss of design and technological leadership over its competition. Low market share was the effect of the Mac’s problems, not the cause. During the ’90s, Apple’s hardware and software both withered. Aesthetically, Macs were simply better-looking beige boxes, sold in an ever-more-confusing matrix of products (look no further than Wikipedia’s entry on Performas). Apple was perennially struggling to achieve CPU parity with Intel’s x86 chips. On the software side, Mac OS was aging, Apple’s attempts at next-generation operating systems all ended in abject failure, and then came Windows 95.

Their hardware was un-sexy, slow, and confusingly marketed. Their OS was technically deficient (remember “cooperative multitasking”?) and just plain looked old next to Windows 95. In short, Apple’s design had faltered across the board.

Their market share, however, was just fine — a peak of 12 percent in 1993, and somewhere around 10 percent through the dark years that followed (in the U.S.).

Jump ahead to 2003, six years after Jobs returned and his NeXT compatriots took control of the company’s executive ranks, and things looked different. With hardware ranging from colorful iMacs to the Titanium PowerBook G4, with a successful transition to the technically and aesthetically modern Mac OS X well underway (embraced by users and developers alike), only the die-hard Apple bear fringe continued to see the Mac (or Apple itself) as doomed.

But Mac market share in 2003 dropped as low as 2.3 percent — far lower than it was in 1996, when Apple was on the brink of bankruptcy.

The recovery of the Mac platform had an inverse correlation to the Mac’s market share. The single decision that came closest to bankrupting Apple was the one to license Mac OS to hardware cloners — a decision that was all about attempting to increase market share for the sake of increasing market share. What the Mac’s success, throughout its entire history, does correlate to is the degree which its design qualities — hardware and software, engineering and aesthetics — were deemed superior to that of its commodity competition by consumers at the high end of the market.

Lastly, the “network effects” drum that Blodget has been banging for years is certainly a real and important factor. But modern computers — PCs, phones, tablets, all of them — are effectively just clients on one universal platform: the Internet. In the ’90s, as the Mac and Apple waned, compatibility meant connecting to Exchange servers, and reading and writing Microsoft Word, Excel, and PowerPoint files. Today, compatibility is a rarely uttered word. Twitter, Facebook, email, and at a lower level, HTTP are available to all platforms.

Jean-Louis Gassée made this argument well, a few days after Blodget’s piece appeared last month:

Interpret history how you will, the facts show something different. Yes, the Redmond Death Star claimed 90% of the PC market, but it failed to capture all the resources in the ecosystem. There was more than enough room for the Mac to survive despite its small market share.

And, certainly, commoditization has been a great equalizer and price suppressant — within the PC clone market. Microsoft kept most of the money with the de facto monopoly enjoyed by its Windows + Office combo, while it let hardware manufacturers race to the bottom (netbooks come to mind). Last quarter, this left HP, the (still) largest PC maker, with a measly 3% operating profit for its Personal Systems Group. By contrast, Apple’s share of the PC market may only be 10% or less, but the Mac owns 90% of the $1000+ segment in the US and enjoys a 25% to 35% margin.

After surviving a difficult birth, a ruthlessly enforced Windows + Office platform, and competition from PC makers large and small, the Mac has ended up with a viable, profitable business. Why not look at iDevices in the same light and see a small but profitable market share in its future?

The point of emphasizing that Apple’s profit share is grossly disproportionate to its market share is not an argument that profit share matters and market share does not. The point is to show that Apple’s customers are demographically different. The Mac today has roughly 10 percent of the PC market, but it’s not just any randomly distributed 10 percent of the market. Quite the opposite — Apple’s 10 percent of the market is entirely comprised of the high end. Mac users are discriminating, willing to pay more for a product they deem superior.

As Ben Bajarin showed earlier today, the iPhone’s market share occupies a similar space in the U.S. phone market:

As you can see, the iPhone dominates the premium segment of the market. These estimates are prior to the launch of the iPhone 5c and iPhone 5s. For that reason, I specifically included devices as low as $400, even though the wholesale cost of the iPhone 5c is an estimated $549. I added that price point because I’m convinced that the iPhone 5c will continue to take share from devices — even those devices in the $400 wholesale range — which are generally priced at free by the carriers. I’m also convinced that this will happen in regions beyond the US, as well.

If I were to include only devices which cost more than $500 wholesale or priced at $99 to $199 on contract, the iPhone’s share would jump to well over 70%. As you can see, the iPhone outsells Samsung’s devices at nearly a 3-1 ratio and other devices at a ratio of 5-1 or higher.

So the irony here is that iOS vs. Android (or, if you prefer, iPhone and iPad vs. commodity smartphones and tablets) is in fact a replay of Mac vs. Windows — but not in the way that most who make the comparison would have you believe. Judging by its actions, Apple is keenly aware of the lessons to be learned from 20 years ago. To wit, this has nothing to do with focusing on raw market share, and everything to do with keeping the pedal to the metal on design and quality. If Apple maintains a lead over its rivals in those regards, the Mac suggests that Apple can occupy a dominant, stable, long-term position as the profit leader in the mobile market as well — a market that is already bigger than the PC market ever was, and unlike the PC market, is still growing.

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So:

Apple bear argument 1: Superior design doesn’t matter in the long run, the mobile market will be commoditized by “good enough” competitors.

Apple bear argument 2: Quality matters but iOS devices have already lost their edge, and are no longer superior to competing devices from Samsung, Google, or Amazon. iOS devices just cost more.

Apple bear argument 3: Design doesn’t matter, app developers and peripheral makers will flock to Android simply because of raw market share, even if that market share is almost entirely at the low end of the market.

What’s interesting is that arguments 1 and 3 are both refuted by the position the Mac holds in the mature PC industry. And I’ll bet that most of the people arguing #2 are the same people who’ve long argued that Macs are in no way better than Windows PCs, and are just overpriced baubles purchased by fools who’ve fallen for Apple’s “marketing”, as though Apple’s advertising effects some sort of Jedi mind trick.

Of the three, the argument I’m most amenable to is #1. The mobile market is being commoditized, just like any other market. The key is that as a consumer market, it will never be fully commoditized.¹ As I quoted Ben Thompson earlier:

Some consumers inherently know and value quality, look-and-feel, and attention to detail, and are willing to pay a premium that far exceeds the financial costs of being vertically integrated.

“Some” need not be “most”, or even all that close to “most”, for Apple to maintain a lucrative position, with a minority of total unit share but a majority of the profits.

The only catch: they need to keep delighting customers.