Does Apple Dominate the MP3 Player & Smartphone Markets?

Apple iPod & iPhone Sales Timeline

How Did Apple Manage the Growth of Its Ecosystem to Create Value?

Would Even More Value Have Been Created If Apple’s System Had Been Open?

A recent article in Newsweek, “Think Really Different” by Daniel Lyons, laments the fact that Apple’s ecosystem is a closed system, which represents paradigm shift from the prior, open system the PC industry and post-Internet world had evolved into:

The Internet is supposed to be all about freedom and choice—yet here comes Steve Jobs with an Internet that is a completely closed system. Apple not only sells you the device, but also operates the only store on the planet that sells software for it. Such "walled gardens" were supposed to be a thing of the past …  Jobs figures he can get away with this radical lockdown because the products Apple makes are so good, outstripping the imaginations of even the most engaged consumer. Jobs argues that this tighter control allows Apple to create a more seamless user experience—your iTunes account stores your credit-card information, which makes it very, very easy to buy stuff. There's no friction … In fact, a closed system may be the only way to deliver the kind of techno-Zen experience that Apple has become known for…

This shift [to a closed system] represents nothing less than a complete rethinking of the past 30 years of tech history, when we've had chips made by Intel and AMD; operating software like Windows made by Microsoft; computers made by Dell, HP, and others; and applications made by thousands of independent software companies. With iPad, Apple is making its own microprocessor and its own operating system—basically, Apple is embracing the old vertical-integration model that was once the norm in the computer industry before the PC revolution Jobs helped create. By having its own microprocessor, instead of a chip that everyone else can use, Apple can tightly integrate its operating system with the chip to get better, faster performance. Rivals won't be able to match it…

Buy into the World According to Steve, and you're making a Faustian bargain—you sacrifice freedom for the sake of a lovely device that (mostly) works just the way it's supposed to, eliminating the headaches and confusion that most tech products bring with them.

What are you giving up? … all the content you buy from iTunes is wrapped in encryption software so that it can run only on Apple devices. If at some point you want to buy another brand of device—some newer, faster, cooler gadget we can't yet imagine—you won't be able to take your Apple content with you. Apple could also decide to block the applications of rival technology [as it did with Google Voice]…

Unless one has had no access to technology news over the past few years, one has not been able to escape the continued hype over the increasing success and dominance of Apple’s device (iPods, iPhones, and imminently iPads) - content (iTunes Store and App Store) ecosystem.  Apple fans have been thrilled with the success of the Apple system and have reveled in the increasing size of the ecosystem, while users and suppliers of competing systems have denounced the fact that Apple has insisted on maintaining a closed, proprietary system.

After thinking about the dichotomy in attitudes between Apple’s supporters, who admire the wondrous size of the pie that Apple’s ecosystem has become, and Apple’s competitors, who disparage Apple for not opening up its system to share the pie with all users and providers, it occurred to me to ask the following question:

If the iPod/iPhone/iTunes/Apps Store ecosystem were not run as a closed system controlled by Apple, would it have become even more successful?

If the ecosystem Apple has created would not have grown to the size it has under an open system, then Apple’s detractors could be described as suffering from a case of sour grapes.  That is, Apple would be said to deserve all it has gained, because it alone was responsible for the ecosystem’s success.

If, on the other hand, Apple’s ecosystem would have grown to a much larger size under an open system, then Apple’s detractors could have a case for claiming that Apple has harmed total social welfare by not opening up its system.  That is, Apple should be denounced for preventing the ecosystem from reaching its full potential.

To answer the question, is Apple’s ecosystem successful because of or in spite of Apple’s actions?, we must first examine the MP3 player and smartphone markets to see if Apple has monopolized these two markets.  If so, then we might conclude that Apple has deterred entry by other suppliers, which might have ended up limiting consumer choice, thereby decreasing social welfare.  Then, we must understand the dynamics underlying the growth of Apple’s ecosystem to determine if the same dynamics/momentum would have existed in an open system.

Does Apple Dominate the MP3 Player & Smartphone Markets? 

The US MP3 Player Market

According to CNET, there are currently at least 81 providers of MP3 players offering a total of 1,781 models, nine of which providers offer at least 50 different models:  Apple (163), Coby Electronics (123), Cowon Systems (62), Creative (152), iRiver (82), Philips (59), Samsung (95), SanDisk (81), Sony (115).

According to Arbitron Inc./Edison Research, the portion of US teens and adults that owned an MP3 player increased from 14% in 2005 to 42% in 2009, and Apple’s share of this market increased from 43% in 2005 to 69% in 2009.  (The first generation iPod was introduced into the market by Apple in October 2001.)

 So despite the fact that there are dozens of providers in the market offering MP3 players, Apple was able to achieve a 50% share if the market by the 5^th anniversary of the iPod, and by 2009 Apple managed to garner 69% of the market.

The US Smartphone Market

According comScore, “The latest report … found smartphones to be used by 42.7 million U.S. adults. Among them, 43 percent favor RIM handsets, while Apple grabbed 25.1 percent market share, Microsoft held 15.7 percent, Google 7.1 percent and Palm 5.1 percent."

In sum, the presence of so many suppliers in the market suggests that Apple has not had a detrimental impact on the availability of competing alternatives.  US market share data indicate that there are while Apple holds the majority of the MP3 player market, it has a large, but trailing position in the US Smartphone market.  This brief analysis suggests that social welfare is probably no lower in the presence of Apple’s proprietary system than it would be under a more open system.  The extent of Apple's success in such crowded markets might even be interpreted as suggesting that social welfare is higher with Apple's current system than it would have been without it, that is, that Apple has been able to satisfy its users more than the competition could have.

Apple iPod & iPhone Sales Timeline

When Apple’s iPod was initially released, it was tailored for group of users most likely to adopt the device: Mac users.  That is, the first generation (1G) iPods were compatible only with Macs and not with PCs.  Apple sold just under a quarter of a million 1G iPods, or 884 per day, during the 10 months after the 1G release until the 2G version was released (see table and graph below).

The 2G iPod was compatible with both Macs and PCs; it sold at a rate of over 1,500 units per day until the 3G version was released.

The 3G iPod had an all touch interface.  After the 3G release, sales soared to 6,786 units per day.

And then with the release of 4G, which had a color screen and picture viewing, sales exploded to almost 55,000 units per day.

With the introduction of the 5G version with video playback, and the addition of video clips to the ITunes Store, iPods  sold at the rate of over 116,000 per day.

Finally, since the introduction of the 6G version and the iPod Touch model, iPods have sold at the rate of over 165,000 per day, though it appears that iPod sales may have peaked during 2008.

The initial iPhone was able to tap into iTunes, so there was already an established source of content available when the model was released.  The initial version of the iPhone sold at a rate of over 16,000 units per day.

The 3G versionof the iPhone was released in conjunction with the opening of the App Store.  With the tremendous success of both iTunes and the App Store the 3G model has sold at a rate of over 67,000 units per day.

How Did Apple Manage the Growth of Its Ecosystem to Create Value? 

Hardware as Vehicles to Consume Content

In many cases hardware devices are used as a vehicle for users to consume content. These types of hardware-software systems (in which content is a form of software) include, for example, TV sets and programming, DVD players and DVDs, CD and music players (stereo systems and MP3 players) and music, e-readers and e-books, telephones and connection services, and Internet accessible devices (computers, netbooks, smartphones, etc.) and the Internet.  In these types of hardware-software systems, it’s really the content users care about (value).  The hardware device, on the other hand, is only valuable to the extent that it enhances the content consumption experience by users.

Hardware can enhance users’ content consumption experiences, for example, by increasing the size, quality, or clarity of the content’s sound, text, and/or picture.  In these cases, large screen TVs are more valuable than smaller screen TVs, high definition TVs are more valuable than traditional TVs, and digital and surround-sound audio systems are more valuable than analog and single sound source systems.

Alternatively, hardware can enhance users’ content consumption experiences by increasing the accessibility of the content.  Content becomes more accessible, for example, when the hardware functions well, it’s easy to use, that is, you can get to the content easily, and/or the hardware is easily portable.

Apple’s ecosystem is a perfect example of a system in which hardware (computers, iPods, iPhones, and now iPads) is used as a vehicle to consume content (business and personal applications, games, music and video, email, Internet, etc.)

Apple Created iTunes, the Largest On-Line Music & Video Store

There is a humongous repository of content that had tremendous value to consumers worldwide:  the global repository of music.  What Apple did with its iPods and iTunes Music Store was to provide consumers with the ability to easily tap into a large portion of this repository anywhere, anytime.  Moreover, continual improvements in the iPod served to continually enhance users’ ability to tap into and manage their own repositories of music, while continual improvements in the iTunes music store served to continually enhance the size of the repository available to users.  In other words Apple continued to enhance and play its content off its hardware and its hardware off its content, so as to maximize the value of the combined ecosystem.

The rest of this section describes the significance of Apple’s iPod/iTunes ecosystem within the realm of the music industry.

The world music industry is concentrated. According to MEI World Report 2000, the “Big Four” commanded 77.4% of the global 2000 market:

• Universal Music Group — 28.8%
• Sony Music Entertainment — 21.1%
• EMI — 14.1%
• Warner Music Group — 13.4%
• Independent labels — 22.6%

The combination of the digitalization of music (CDs), together with the ability to costlessly distribute unlimited numbers of copies over the Internet, caused the Big Four to quickly lose control of the market to pirating.  According to the International Federation of the Phonographic Industry (IFPI) , the global music market was worth US$ 36.9 B in 2000 and $18.4B in 2008 (comprised of $13.8B physical sales, $3.8B digital sales, and $0.8B performance rights).

According to a BusinessWeek article in 2000, “EMusic.com: A Third Way in the Digital Music Battle” by Spencer E. Ante:

There's a revolution going on in the recording industry, as entertainment giants and Internet upstarts face off over digital music. On one side of the barricades stand major record labels such as Sony, Universal, and BMG -- the Establishment -- which are trying to maintain a tight grip on intellectual property and an ossified distribution system. On the other side are digital music enthusiasts -- call them the anarchists -- who've embraced new technologies like MP3 and Napster that promote a more open, and in many cases pirated, flow of music…

Later this summer, they [the majors] plan to start selling downloadable digital music using digital rights management, or DRM, technologies. DRM acts like a digital envelope, securing a piece of content with rules that determine how it can be used … using DRM will alienate customers. "There are enough barriers to entry to buying music that adding new ones isn't productive … Using DRM is an implicit distrust of your customer"…

But when the big record companies do start selling, the million-dollar question will be this: Will consumers buy secure music? It's possible, but with the free-download mentality so well entrenched among college kids and teens -- the Net's primary music consumers -- it's not likely to be a huge success…

Early entrepreneurs of business that provided sales of downloadable music were unable to convince any of the Big Four to sign on.  In other words, ventures into online music stores were unsuccessful because they were able to include only a small fraction of the total repository of songs in their stores.

The initial version of iTunes released by Apple in 2001 was a music management system, but not a store; that is, it enable Mac users to manage the music contained in their own libraries, but it did not enable users to purchase music through iTunes: 

Apple Introduces iTunes — World’s Best and Easiest To Use Jukebox Software

MACWORLD EXPO, SAN FRANCISCO—January 9, 2001—Apple® today introduced iTunes, the world’s best and easiest to use “jukebox” software that lets users create and manage their own music library on their Mac®. iTunes lets Mac users import songs from their favorite CDs; compress them into the popular MP3 format and store them on their computer’s hard drive; organize their music using powerful searching, browsing and play list features; watch stunning visualizations on their computer screen; and burn their own audio CDs — all in one easy-to-use application. Exclusively for Mac users, iTunes is available as a free download from www.apple.com.

However, the version of iTunes released by Apple in 2003, the iTunes Music Store, included a store, revolutionary in the fact that it enabled users to purchase music from the Big Four (the "Big Four" used to be the "Big Five" until Sony and BMG merged in August 2004):

Opening as the iTunes Music Store on April 28, 2003, with over 200,000 items to purchase, it is, as of April 2008, the number-one music vendor in the United States…

The store began after Apple signed deals with the five major record labels at the time, EMI, Universal, Warner, Sony Music Entertainment, and BMG.

Apple Masterfully Managed its Device-Content Ecosystem

With the release of its iPod, there had already been a long history of portable music players on the market.  So, Apple’s success with the iPod cannot be attributable to Apple’s system being the first of its kind.  So then what is it that makes the iPod system so valuable?  It’s the combination of (1) the sleek and sexy devices, (2) a nifty, user-friendly means of managing content on the device, and (3) the large, ready supply of easy-to-access content (iTunes) available anytime from anywhere.  As previously mentioned, Apple has done a masterful job of continually enhancing and playing its content (creating iTunes, the content management system; morphing iTunes into The iTunes Music Store by expanding it to includes online sales of music; and then expanding it again to the iTunes Store, by including online sales of video content) off its hardware (start with Mac-only accessible iPods, expanding to include Windows users, then adding video capabilities) and its hardware off its content, so as to maximize the value of the combined ecosystem.

As with the iPod, with the release of the iPhone, there had already been a substantial history of other smartphones on the market, including those by Nokia and RIM. So then why has the iPhone been so successful?  Again, it’s the same combination of (1) the sleek and sexy devices, (2) a nifty, user-friendly means of managing content on the device, and (3) the large, ready supply of easy-to-access content available anytime from anywhere.

Had Apple quit with the iPod and iTunes, it would have continued to generate profits for quite sometime.  However, Apple’s tremendous success is do to the fact that not only was Apple able to create the iPod-iTunes phenomenon, but that it was able to continue to build on the hardware and the software (content) in the ecosystem so as to continually enhance the system’s value.  In particular, after initially creating the iPod-iTunes ecosystem, Apple was able to further monetize the value of iTunes by adding another device (the iPhone), this one with cellphone features, which could tap into the repository of available content (iTunes).  At the same time, Apple was able to increase the value of both its devices (the iPod and the iPhone) by greatly increasing the variety of content available to users (via the App Store), using the same easy-to-access system available anytime from anywhere.  And now Apple is continuing to monetize the value of its humongous repository of content (iTunes and Apps) by adding yet another device to the system (the iPad), which will further enable Apple to grow the size of it content available (by adding e-books, new iPad apps, etc.)

To reiterate, Apple’s continued success may be attributed to its masterful job of continually enhancing and playing content off hardware and hardware off content, so as to maximize the value of the combined ecosystem.

Would Even More Value Have Been Created If Apple’s System Had Been Open?

Now that I have a better understanding of the underlying dynamics of Apple’s device-content ecosystem, I can try to answer the original question posed: If the iPod/iPhone/iTunes/Apps Store ecosystem were not run as a closed system controlled by Apple, would it have become even more successful?

So, yes, Apple did a great job of creating an easy-to-use system for managing and purchasing music and video (i.e., creating the iTunes Store) and of convincing the Big Four to include its music in the store.  But wouldn’t iTunes have become even more successful if other MP3 players could access the store, instead of just Apple’s devices?

On February 6, 2007, Steve Jobs published “Thoughts on Music”, which explains why Apple does not allow purchased music from iTunes to be loaded onto non-Apple devices.  In short, the only way Apple could get the Big Four to agree to provide their music for sale on iTunes was to agree to the closed (DRM-protected system):

With the stunning global success of Apple’s iPod music player and iTunes online music store, some have called for Apple to “open” the digital rights management (DRM) system that Apple uses to protect its music against theft, so that music purchased from iTunes can be played on digital devices purchased from other companies, and protected music purchased from other online music stores can play on iPods…

The rub comes from the music Apple sells on its online iTunes Store. Since Apple does not own or control any music itself, it must license the rights to distribute music from others, primarily the “big four” music companies: Universal, Sony BMG, Warner and EMI. These four companies control the distribution of over 70% of the world’s music. When Apple approached these companies to license their music to distribute legally over the Internet, they were extremely cautious and required Apple to protect their music from being illegally copied. The solution was to create a DRM system, which envelopes each song purchased from the iTunes store in special and secret software so that it cannot be played on unauthorized devices.

And it’s not just Apple that has its own proprietary systemsystem – Microsoft and Sony each have their own proprietary system as well.  Steve Job’s “Thoughts on Music” continues:

…each manufacturer compet[es] freely with their own “top to bottom” proprietary systems for selling, playing and protecting music. It is a very competitive market, with major global companies making large investments to develop new music players and online music stores. Apple, Microsoft and Sony all compete with proprietary systems. Music purchased from Microsoft’s Zune store will only play on Zune players; music purchased from Sony’s Connect store will only play on Sony’s players; and music purchased from Apple’s iTunes store will only play on iPods. This is the current state of affairs in the industry, and customers are being well served with a continuing stream of innovative products and a wide variety of choices.

So even if the Big Four had allowed Apple to sell their music on iTunes without any DRM protection, it’s not clear that the system would have been “open”.  In particular, Microsoft and Sony may very well have continued to maintain their own, closed, proprietary systems.

Yet, the whole notion of it being a closed system (or set of closed systems, with Apple, Microsoft, and Sony each supporting his own system) is a bit of a misnomer.  As Steve Jobs points out:

Some have argued that once a consumer purchases a body of music from one of the proprietary music stores, they are forever locked into only using music players from that one company. Or, if they buy a specific player, they are locked into buying music only from that company’s music store. Is this true? Let’s look at the data for iPods and the iTunes store – they are the industry’s most popular products and we have accurate data for them. Through the end of 2006, customers purchased a total of 90 million iPods and 2 billion songs from the iTunes store. On average, that’s 22 songs purchased from the iTunes store for each iPod ever sold.

Today’s most popular iPod holds 1000 songs, and research tells us that the average iPod is nearly full.  This means that only 22 out of 1000 songs, or under 3% of the music on the average iPod, is purchased from the iTunes store and protected with a DRM. The remaining 97% of the music is unprotected and playable on any player that can play the open formats.  It’s hard to believe that just 3% of the music on the average iPod is enough to lock users into buying only iPods in the future.  And since 97% of the music on the average iPod was not purchased from the iTunes store, iPod users are clearly not locked into the iTunes store to acquire their music.

What I now have is that in the absence of Apple’s use of DRM protection, Apple would not have been able to convince the Big Four to include their songs in the iTunes Store, so the iTunes Store would have contained fewer choices than it currently does.  In the end, the portion of the songs actually consumed by iPod users that were purchased through iTunes from one of the Big Four appears to be small (on the order of 3% or less, according to Steve Jobs).   As such, one might conclude that Apple did not, in fact, need to maintain a proprietary system at all, and that it could have become as successful, if not more so, had it been maintained as an open system.  However, this conclusion would fail to take into account the importance that inclusion of the Big Four’s songs in iTunes had on helping the iPod-iTunes ecosystem initially attract users, gain momentum early on, and eventually achieve the critical mass that’s the necessary precursor of a successful ecosystem.  While it’s not for sure that the inclusion of the Big Four’s songs in iTunes was the determining factor, this cannot be ruled out, since at the time Apple introduced the iPod and the iTunes music store, there were other music stores and MP3 players available on the market.  Without the initial value provided to users of the iPod-iTunes ecosystem from the large available repository of songs from the Big Four, users might just have easily adopted a different system, in which case the Apple ecosystem might not have become as successful as it did.

At the same time, had Apple maintained an open system and foregone inclusion of the Big Four’s music in the iTunes store, the “open” system that would have included Apple’s iPods and iTunes Store might not have included many other devices and content, which would have been the case, for example, if Microsoft and Sony had still maintained their own proprietary systems.

Let’s move on to the App Store. The iPod/iPhone/App Store ecosystem is a closed system because Apple's apps can only be downloaded on Apple's devices and because Apple controls which apps may be included in the App Store.  What would have happened to the iPhone and App Store success if Apple had not insisted on such a closed system?

According to the initially cited article, “Think Really Different” (the emphasis in the last sentence is mine),

Jobs argues that this tighter control allows Apple to create a more seamless user experience—your iTunes account stores your credit-card information, which makes it very, very easy to buy stuff. There's no friction. Thinking about an old song from high school? Go to iTunes, grab it, pay a buck, and listen. I do that all the time now on my iPhone, and I'll probably make bigger purchases—movies, books, TV series—for my iPad. In fact, a closed system may be the only way to deliver the kind of techno-Zen experience that Apple has become known for.

This "techno-Zen experience that Apple has become known for" is what presumably led one developer to comment later in the article that "Apple has created an ecosystem that consumers trust. It's a very compelling place to be as a developer."  Compare the experience users and developers get from the seamlessly integrated Apple ecosystem, as compared with users’ and developers’ experiences with Google’s fragmented Android system:

Platform Fragmentation from “Exclusive: Android Froyo to Take a Serious Shot at Stemming Platform Fragmentation” by Chris Ziegler, March 29, 2010

We had a couple people at CTIA last week -- people whose words carry weight -- tell us off the record that the next major version of Android would take big strides toward stopping the ugly trend toward severe fragmentation that has plagued the platform for much of this and last year. You know, the kind of fragmentation that has already left users running not one, not two, not three, but four distinct versions of the little green guy (1.5, 1.6, 2.0, and 2.1) depending on a seemingly arbitrary formula of hardware, carrier, region, software customization, and manufacturers' ability to push updates in a timely fashion. Put simply, Google's been iterating the core far faster than most of its partners have been able to keep up.

App Store Location Fragmentation from “Three Places To Shop For Android Apps? How Confusing!” by Sarah Perez, October 23, 2008:

Yesterday, T-Mobile stocked their stores with G1 handset, the first smartphone to feature Google's mobile operating system "Android." Along with the device itself, the Google Android Market also went live. There, developers are offering a number of applications for installation on the new phone. However, the Android Market isn't the only place to get apps. Both Handango and MobiHand have app stores of their own. Will this open ecosystem be good for the "Google phone" or will it lead to consumer confusion?

One of the biggest differences between Google's Android and Apple's iPhone is the open nature of the Android ecosystem. Although consumers see the G1 as a direct competitor to the iPhone, comparing the two is really like apples (ha!) and oranges. Apple manufactures both the hardware and the software for the iPhone, whereas Google only provides the mobile OS itself. A more apt comparison would be to compare Android to Windows Mobile. And given the rise of multiple sites for Android apps, that comparison is now more applicable than ever.

Handset Manufacturers’ Hardware Fragmentation from “Differentiation Leads to Fragmented, Confused Android” by Scott Webster, November 25, 2009:

One year after the introduction of the T-Mobile G1, three of the top-four carriers in the United States are offering Google Android handsets. And with each model bringing something new and unique to the market, everything is rosy, right? Not so fast. While differentiation is one of the key benefits behind Android, it's leading to fragmentation. Thus, one of the biggest benefits is becoming a drawback.

At the time of this writing, there are three versions of Android on the market. On Verizon Wireless, the recently released Motorola Droid has Android 2.0, while the carrier's HTC Droid Eris is running Android 1.5 under the Sense UI. The phones were released on the same day yet they are on polar opposites in terms of Android.

What's more, there are four other handsets running Android 1.5: Sprint's HTC Hero and Samsung Moment, and T-Mobile's Samsung Behold II and Motorola Cliq. And what about the first two Android phones, the G1 and MyTouch 3G? Both handset have Android 1.6 under the hood. Confused yet?

The differences stem from the desire handset manufacturers have to differentiate themselves. Rather than go for the stock Android experience, companies are opting to add their own flavors to help stand out. The problem is that Android's updates come from the handset maker and not Google. As we're learning, it could be months before HTC or Motorola catch their handsets up with 1.6, let alone 2.0.

By then it's not unrealistic to think that Google will be ready to push its next build (Flan) out to handsets. And remember that much anticipated Sony Ericsson Xperia X10? Though it's not expected until February, it too is slated to have 1.5 unless the company can get 1.6 or 2.0 loaded before it heads out the door.

This is becoming confusing and discouraging to current and potential customers. Normally, the newer the phone, the more advanced the operating system. But with Android, the two oldest phones have more software capability than the six that followed. Imagine the frustration of saving up a couple hundred dollars to get the latest and greatest handset only to find that older phones have more potential. Google recently made its Google Maps Navigation available to Android 1.6 devices. Sadly, this still leaves over half of all Android phones without the feature.

It doesn't get any easier for developers. Many are practically pulling their hair out over minor updates and bug fixes. With each new handset comes a different camera video tweak or extra line of code to address video drivers. Differentiation in hardware is just as big of a headache. It might not be a bad idea for Google to step up and set some standards or recommend specific hardware. The sooner all of these things are addressed, the better.

It seems pretty clear that Apple’s seamless ecosystem has been a significant contributing factor to its success.

What we’re left with, then, is a pretty good sense that the Apple ecosystem is successful because of Apple’s insistence on maintaining a closed system, and that had the system been more opening, it’s very likely it would not have become as successful as it has.