Winning the Hardware Software Game Winning the Hardware-Software Game - 2nd Edition

Using Game Theory to Optimize the Pace of New Technology Adoption
  • How do you encourage speedier adoption of your product or service?
  • How do you increase the value your product or service creates for your customers?
  • How do you extract more of the value created by your product or service for yourself?

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Latest Comments

  • Anonymous said More
    Well written. Well constructed. Tuesday, 13 August 2019
  • Ron Giuntini said More
    As always a good read.
    I have always... Thursday, 25 January 2018

Amazon

Apple

Amazon vs Apple

 

I just Googled “Apple” and “Amazon” and “war” and got 40,300,000 hits, with such headlines as

The Amazon-Apple War Is On

New $199 Amazon Kindle Stokes Fire in War With Apple

Amazon Ignites Tablet War with Fire, Takes on Apple

The Amazon-Apple War Is On - Kindle Fire, 7" Tablet for USD199

But is Amazon’s release of its new tablet really an indication that it is trying to take on the Apple ecosystem?  I don’t think so.

Amazon

In its 1999 10K Report, Amazon describes itself as a consumer media retailer that “offers its customers a superior shopping experience” (emphasis mine):

Amazon.com, Inc. ("Amazon.com" or the "Company"), the Internet's number one book, music and video retailer, opened its virtual doors on the Web in July 1995. Amazon.com, one of the most widely known, used and cited commerce sites on the Web, offers more than 4.7 million book, music CD, video, DVD, computer game and other titles. The Company offers its customers a superior shopping experience by providing value and a high level of customer service. Amazon.com is a proven technology leader; it has developed electronic commerce innovations such as 1-Click ordering, personalized shopping services and easy-to-use search and browse features. Shopping at Amazon.com is fast and safe, incorporating a simple ordering system, secure credit card transactions, e-mail communication with customers and direct shipping worldwide.

By the following year (2000 10K Report), Amazon has expanded its retail offerings to include other, non-media merchandise, but it still stressed its “superior shopping experience” (emphasis mine):

We directly offer for sale millions of distinct items in categories such as books, music, DVDs, videos, toys, electronics, software, video games and home improvement products... We offer our customers a superior shopping experience by providing high value through selection, convenience, ease of use, low prices, product information and an intense focus on customer service. We are a proven technology leader, having developed electronic commerce innovations such as 1-Click technology, personalized shopping services, easy-to-use search and browse features, secure payment protections and wireless access to our stores... These new [distribution] facilities increase our control over the distribution process and facilitate our ability to deliver merchandise to customers on a reliable and timely basis.

Amazon thus describes itself as a consumer retailer that offers media and merchandize for sale to consumers. Amazon attributes its success as an Internet retailer to its strategy of offering its “customers a superior shopping experience by providing high value through selection, convenience, ease of use, low prices, product information and an intense focus on customer service.”

Now consider the distribution of Amazon’s historical revenues between sales of media and sales of other, non-media merchandise, as presented in the following graph:

As can be seen in the graph, during Amazon’s early years, its sales of media strongly dominated its sales of other merchandise. However, over time, merchandise sales have grown faster than have media sales, to the point that merchandise sales currently account for the majority of Amazon’s sales.

With the advent of digital media, certain market forces -- including decreasing marginal costs of supply, leading to widely available (not all of it legally) free content -- have pushed toward the commoditization of media. I think Matt Asay in “'Free' is(n't) a four-letter word...” sums it up best when he said:

The problem (and promise) of digitization is, of course, "free." Everyone loves to pay "free"…

Given the trends toward commoditization of digital media, it makes sense that Amazon has protected its margins by expanding its offerings to also include sales of general merchandise.

Moving forward, though, how does Amazon continue to grow sales? From its 2011 10K Report, Amazon states:

We believe that the principal competitive factors in our retail businesses include selection, price, and convenience, including fast and reliable fulfillment. Additional competitive factors for our seller and enterprise services include the quality, speed, and reliability of our services and tools.

According to Amazon, it addresses these factors as follows:

Selection: “We design our websites to enable millions of unique products to be sold by us and by third parties across dozens of product categories.”

Low Prices: “We strive to offer our customers the lowest prices possible through low everyday product pricing and free shipping offers, including through membership in Amazon Prime, and to improve our operating efficiencies so that we can continue to lower prices for our customers.”

Convenience and Ease of Use: “Amazon.com is a proven technology leader; it has developed electronic commerce innovations such as 1-Click ordering, personalized shopping services and easy-to-use search and browse features. Shopping at Amazon.com is fast and safe, incorporating a simple ordering system, secure credit card transactions, e-mail communication with customers and direct shipping worldwide.”

Fulfillment: “We fulfill customer orders in a number of ways, including through the U.S. and international fulfillment centers and warehouses that we operate, through co-sourced and outsourced arrangements in certain countries, and through digital delivery. We operate customer service centers globally, which are supplemented by co-sourced arrangements.”

Moving forward, the biggest challenge Amazon faces is to continue to provide convenient and easy to use access and ordering as its customers’ lifestyles change. How are customers’ lifestyles changing? They’re becoming more mobile. In “Tablets wars: Apple is from Venus, Amazon is from Mars”, Om Malik indicates that

the Internet is increasingly becoming a mobile-first experience. Our online behaviors are changing from browsing on the web to browsing on the go, whether on tablets or smartphones. If Amazon has to stay relevant, it needs to embrace this new world.

Amazon has already provided a massive amount of retail goods available anytime. Now it needs to maximize ease of access to its goods from anywhere. However, customers are very fickle. If they cannot quickly and easily purchase what they want from Amazon, when they want to purchase it, they will move on to some other retailer that can.

This is where the Kindle Fire comes in. The Kindle Fire provides customers with a quick and easy ordering and fulfillment option whenever and wherever they want to buy something. More specifically, the Kindle Fire has been designed to provide Amazon customers with the fastest (dual core processor, Silk browser), most convenient way to purchase Amazon merchandise and to purchase and use Amazon media.

Furthermore, since Amazon hopes the Kindle Fire will facilitate sales of Amazon products, Amazon is offering the device at a low price (purportedly below cost). That is, it’s using buns as a loss leader so as to sell more hot dogs.

In sum, Amazon is a retailer of consumer products, and it’s providing the Kindle Fire as a means of facilitating purchases of its consumer products as consumers become more mobile. That is, Amazon’s ecosystem revolves around its content.

 

Apple

When Apple first started out (it was incorporated in 1977), it was clearly a hardware vendor. 17 years after being founded, Apple was still generating the majority of its revenues from sales of personal computers. From Apple’s 1994 10K report:

The Company designs, manufactures and markets microprocessor-based personal computers and related personal computing products .. Substantially all of the Company's net sales to date have been derived from the sale of personal computers from its Apple Macintosh line of computers and related software and peripherals. The Company operates in one principal industry segment across geographically diverse marketplaces.

Prior to 2001, Apple was still clearly a hardware vendor. It developed and sold hardware (personal computers) that ran on its proprietary operating system, it provided software and accessories for its hardware, and there was a limited amount of third-party software and accessories for its hardware.

In early 2001, Apple established the iTunes Store (source of third-party digital content and applications available for purchase and download on digital hardware), then later that same year, Apple introduced the iPod (portable MP3 player). If ones defines a technology ecosystem as a system in which proprietary and third-party hardware, content, and accessories are provided that all work together, then 2001 marks the year that the Apple platform-based ecosystem was established.

The Apple ecosystem creates value for users through three interlinking components that all work together to create a whole that’s more valuable (via network effects) than the sum of its parts:

  • A variety of hardware devices that address the gamut of consumers’ digital production and communication needs;
  • A large, diverse supply of content, most of it cheaply available; and
  • An hardware-content interface providing “superior ease-of-use, seamless integration, and innovative industrial design”.

The user experience created by Apple when all three of these components are jointly provided enable Apple to charge a premium for its hardware. This is how Apple monetizes the “extra” value created by the sum of the ecosystem parts. If there were not as much content available as there is, and/or if the content were generally expensive, and/or if the devices and content did not integrate “seamlessly”, then Apple would not be able to sustain its high margins on sales of its hardware. To be able to continue generating high margins on sales of devices, then, Apple strictly adheres to its policy of tightly managing its ecosystem, so as to ensure a superior consumer experience for all users of its devices. From Apple’s 2010 10K Report (bold print mine):

The Company is committed to bringing the best user experience to its customers through its innovative hardware, software, peripherals, services, and Internet offerings. The Company’s business strategy leverages its unique ability to design and develop its own operating systems, hardware, application software, and services to provide its customers new products and solutions with superior ease-of-use, seamless integration, and innovative industrial design... In conjunction with its strategy, the Company continues to build and host a robust platform for the discovery and delivery of third-party digital content and applications through the iTunes Store... The Company also works to support a community for the development of third-party software and hardware products and digital content that complement the Company’s offerings. Additionally, the Company’s strategy includes expanding its distribution to effectively reach more customers and provide them with a high-quality sales and post- sales support experience. The Company is therefore uniquely positioned to offer superior and well-integrated digital lifestyle and productivity solutions.

So we have

Tightly Managed Apple Ecosystem

=> Superior User Experience

=> Premium Priced Apple Hardware

During the early 2000s, the profit opportunities created by the large population of users with iPods attracted large numbers of content (and accessories) providers to provide content for iPod (and Mac) users, most of which was low-priced. As the amount of content available mushroomed, the value of Apple hardware (iPods and Macs) mushroomed with it (otherwise known as feedback effects). Apple continued to monetize the increasing value of its ecosystem (1) by regularly introducing new premium-priced devices to the ecosystem, all of which “seamlessly” integrated with the other hardware and content in the ecosystem; and (2) by tightly managing the supply of third-party content to make sure the content “seamlessly” integrated with the other hardware and content in the ecosystem.

To verify that Apple does indeed generate most of its revenues from sales of hardware, let’s look at the distribution of Apple’s historical revenues:

In the graph above, sales of Mac desktop and portable computers have decreased from 80 percent of Apple’s revenues during the early 2000s, to just over a quarter of its revenues in 2010. The drop-off in revenues from sales of Mac computers has been perfectly offset by sales of its other hardware (mobile) devices as they’ve come onto the market. While the amount of revenues generated by sales of digital media through iTunes and the App Store have exploded, they’ve continued to constitute only about 10 percent of Apple’s total sales.

In sum, Apple is a vendor of premium-priced hardware products. Apple established a platform-based ecosystem surrounding its devices, and it strictly manages the ecosystem, so as to continue to be able to charge premium prices for its hardware.

 

Amazon vs Apple

Here’s what we have.

Amazon is a consumer retailer of media and other merchandise. Over time, Amazon has been generating a larger portion its revenues from sales of merchandise relative to that from sales of media. The Internet, the channel through which Amazon generates all of its sales, is increasingly being accessed by users on the go through mobile hardware devices. As such, for Amazon to continue to grow its revenues, it has introduced the Kindle Fire so as to optimize mobile users’ ability to purchase Amazon products. In brief, Amazon’s hardware facilitates product sales.

Apple is a consumer retailer of premium-priced hardware devices. Over time, Apple has been able to continue to charge a premium for its hardware by ensuring both (1) that there is a plentiful supply of (cheap) content (and accessories) for its hardware devices, and (2) that hardware users can seamless access content from any of Apple’s hardware devices. So, Apple’s content facilitates sales of hardware.

Regardless of the fact that the two companies are coming from opposite directions, one using hardware to sell “content” and the other using content to sell hardware, the real question is: are they catering to the same market? If so, then it may very well be war. But if the two ecosystems are not catering to the same market, then they could very well amicably co-exist in the marketplace.

Returning to the two companies’ self-described strategies, Amazon provides media and non-media merchandise to its customers, while Apple provides digital production, consumption, and communications “lifestyle” to its customers. While there is some overlap in the area of sales and consumption of digital media, the larger part of the two companies markets do not overlap. I conclude, then, that Amazon and Apple should both be able to continue to thrive.

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