Issue 11

When Apple's walls came down

Delivered on 25 November 2018 by Justin Pyvis. About a 5 min read.

A hallmark of Apple over the past two decades (perhaps longer, my Apple history isn’t the best) has been its “walled garden”; the Apple “ecosystem”, where if you buy one Apple product you’re going to want to buy more because they don’t play well with others. As Steve Jobs used to say, if you had an Apple product, “it just works”. And one reason for that were the limitations that Apple placed on every device in its ecosystem: hardware; software; apps; even the accessories. It all had to be Apple, or it would become a major pain in your backside.

I’m not sure if Steve Jobs was familiar with the path dependency literature, or whether he was just a smart guy who realised that once consumers had learnt how to use one of his products, if the switching costs were high enough then they would be more likely to just stay with Apple.

A bit of background for those new to the concept: everyone who has used a computer probably did so with a QWERTY keyboard. Economists used to cite it as a clear example of “market failure”, where producers and consumers were “locked-in” to an inferior standard. A competitor, the Dvorak layout, was technically superior in terms of pure typing speed but people didn’t switch.

Two economists decided to investigate the phenomena in more detail (Stan Liebowitz and Stephen Margolis). They concluded that the cost of retraining to get everyone using a Dvorak keyboard was not worth paying - that is, the efficiency gains from switching were not large enough to overcome the costs of switching. Even in a situation where a company has a monopoly as a result of network effects (e.g. everyone I know uses an iPhone, so having an iPhone is more important to me), there’s no coordination failure:

These monopolies … are efficient outcomes in network industries, where the network effect, or scale economy, is strong. It is not our argument that such monopolies would never arise, but rather that these monopolies would not be locked in. Such industries are serial monopolies; one monopoly after another. … The stakes are always high in such industries. The new entrant seeks not to coexist with the incumbent, but rather to replace it. These high stakes, and the rivalry that they create, is apparently sufficient discipline to hold monopoly prices in check and to keep the rate of innovation very rapid.

Steve Jobs’ time at Apple was all about lock-in, especially with mobile devices. If you used an Apple device your life would be a lot easier if you also used iTunes, iMessage, iCloud, Apple Mail, Apple Maps, the App Store, not to mention a myriad of Apple-specific accessories. You had to. Apple’s software either didn’t exist outside of the Apple ecosystem, or if it did, didn’t play well with non-Apple hardware. Steve Jobs essentially built digital walls that you would have to climb over to get out, a painstakingly time-consuming process that was often not worth the potential financial savings.

But as Google’s Android developed into a legitimate competitor to Apple’s iOS operating system and third party hardware manufacturers such as Samsung caught up, that changed.

Well they blew the horns And the walls came down They’d all been warned And the walls came down They stood there laughing They’re not laughing anymore The walls came down — The Call

In 2016, faced with declining iPhone unit sales for the first time ever, Apple opened upApple Maps, Siri and iMessage to third party developers with the idea being that it would boost revenue in its core business, iPhone sales. But it didn’t work as well as hoped, with sales continuing to plateau. So Apple took a different tack: services. To do so, Apple had to dismantle the wall even further by allowing developers even more access to its phones.

With device sales stagnating, Apple declared services to be the future, as virtually all of its revenue growth was coming from the App Store and licensing agreements (more on that later). And earlier this month, the company - to deflect investor attention from sales of its devices - announced that it would no longer report unit sales for three of its most important products, the iPhone, iPad and Mac. Investors weren’t impressed.

Goldman estimates that Apple now generates almost $9 billion from its licensing agreements with Google. Google! A company upon which Steve Jobs once declared a “holy war”. $3 billion of that is so that Google is set as the default search engine on Apple’s devices. So for all of Apple CEO Tim Cook’s moral posturing about the importance of user privacy and the evil “data industrial complex”, his actions reveal that he’s more than happy to trade it for a cheeky billion or three. But that’s a story for another day.

Essentially, the days of Steve Jobs’ walled garden and his “holy war” against Google are gone. Apple is now dependent on not just removing the wall’s remaining rubble, but paving a path into its ecosystem so that it can continue to grow services revenue. For while it’s all well and good to sell your users’ privacy to Google for a quick buck, Apple’s core business remains just as dependent on iPhone sales as it has been for years; its App Store commissions are directly related to the number of people using Apple devices. All else equal, fewer Apple devices translates into less App Store revenue.

How Apple plans to move forward from here, I’m not sure. While Google has its entire array of applications on Apple’s App Store, I could only find Apple Music, Beats Pill+ and a “Move to iOS” app on Google Play. Incidentally, Apple Music - for which it charges a recurring $9.99 monthly fee - is one of the company’s fastest-growing services.

Most of Apple’s software has thrived inside the walled garden. But with the walls coming down, will it be able to compete on a level playing field? Once you take away the iPhone, how does iCloud stack up against Dropbox and Google Drive? Can Apple compete with Microsoft’s Azure or Amazon’s AWS (Amazon’s most profitable division)? I’m not so sure.

Issue 11: When Apple's walls came down was compiled by Justin Pyvis and delivered on 25 November 2018.