Is Apple killing software biz as we knew it with iPhone, iPad and iOS? Part I: Show me the money

The original iPhone launched the global smartphone wars and shifted the personal computing balance of power forever. Google rose to the challenge, responding with Android, whereas Nokia, Blackberry, Microsoft, HP and Dell have been shunted aside. Nearly every smartphone sold these days is either an Android or iPhone.

Forget which smartphone you think is the best, or which OS you believe is superior, or who has the better smartphone “ecosystem”. Instead, consider the business model differences between these two primary combatants, iPhone and Android. Could it be that the Apple model of selling hardware to the user is the only sustainable option?

There are fundamental differences between how Google offers Android and how Apple offers iPhone. For Google, while they maintain control over ongoing development of Android, the mode of sales is via licensing. Follow Google’s guidelines and they let you have Android for free. They also give you Google Search, Voice Search, Google Maps, Google+, which includes video calling, and much more – all free. This has worked amazingly well, provided we do not consider profits. With license partners including Samsung, LG, Sony, Lenovo and many more, there are well over 100 million Android devices sold every quarter, a truly remarkable feat.

Apple follows a completely different path with iPhone. There is no licensing. Apple is fully responsible for hardware and software, for the media store and app store, for payments and updates – they even design their own chips. The result of these two very different strategies has been that Android has captured the largest share of the market, by far, while iPhone rakes in the bulk of the profits, by far.

I believe Apple has the superior business model – by far.

The “smartphone wars” are not a parallel of the PC wars. There, Microsoft won handily. Apple’s Mac, tightly controlled by Apple, was relegated to niche status – in terms of market share, revenues and profits. Too many pundits mistakenly believe the smartphone wars will offer a repeat:  Google Android as the new Microsoft Windows. Apple iOS as the new Apple Mac. iOS and iPhone are destined to be minor players, they say. The giant smartphone market will standardize around Android.

This is wrong for several reasons. Firstly, today’s Apple is bigger and richer by far than either Google or Microsoft. Today’s Apple has a massive global retail footprint, with nearly 400 stores that generate about $16 billion annually. This also means Apple can better support (and promote) their products, far better than either Microsoft or Google. Thanks to App Store and the Mac App Store, where once it was difficult to buy software for your Apple product, today it may be easier than for any other computing platform. No one else has these advantages. Apple will not be marginalized.

Apple’s massive size and scope, today, however, do not guarantee continued success into the future. Both Google and Microsoft are aiming for them. However, I believe there is a second assumption people hold regarding the smartphone wars that is equally erroneous: that software trumps hardware.

The evidence plainly suggests otherwise.

About a year ago, famed Internet investor Marc Andreessen wrote the following in the Wall Street Journal:

Software is eating the world.

More and more major businesses and industries are being run on software and delivered as online services—from movies to agriculture to national defense. Today, the world’s largest bookseller, Amazon, is a software company…Today’s largest video service by number of subscribers is a software company: Netflix.  Today’s dominant music companies are software companies, too: Apple’s iTunes, Spotify and Pandora.

What if he got it completely wrong? After all, Amazon has meager profits. Netflix is hurting and Apple’s iTunes barely does better than break even. It would seem as if software (and digital content) are not the path to profits. This cannot last. While companies may go without profits for a short time, and some may fund unprofitable ventures for years, eventually the business must earn its keep or get shut down.

The smartphone wars are fundamentally shifting the industry. The idea that software is “eating the world” may be a relic of the past. The real money is in hardware. If so, expect Apple to continue to pull away from the competition.

We are told repeatedly, for example, that Apple’s profit margins must come down and that Apple’s pricing power is under constant threat.

Why?

Simple: because the competition can actually lose money on hardware and still make a profit.

I say this is a false belief.

Consider that the sole reason for Google to spend so much on Android is to better capture our personal data and then sell that data to advertisers. Google’s money comes from advertising, not from selling Android. Except, Apple continues to generate more profits off its smartphone hardware than Google does off its smartphone software and services. It’s not even close.

The story’s the same with tablets. The Apple iPad continues to dominate the tablet market. However, Amazon, which created their fork of Android, offers the popular Kindle tablet line, which is priced much lower than iPad.

This is not because Apple’s costs are so high. Rather, because Amazon, like Google, makes up the difference through software, services and content. Not only does Amazon make little on hardware, they may actually lose money on each Kindle sold. That’s their strategy: sell as many of these hardware devices as possible, as low-priced as possible, and make it up on software, services and digital content. In Amazon’s case, by selling hardware at a loss they expect to ultimately gain by generating more retail transactions, selling more subscriptions to Amazon Prime, selling (or renting) streaming video and offering other services.

I say Apple’s competitors are doing it all wrong.

Consider that of the 100% of smartphone device profits, Apple, focused on hardware, gobbles up an astounding 60%. I recently predicted that Samsung would acquire Android outright given that this hardware company is making more on Android than Google. Would you be surprised to learn that now analyst Asymco suggests that Samsung is generating so much profit from Android hardware that it could acquire Google itself, not just Android?

If the money is in software, how can this be? Perhaps a new rule for the smartphone wars is that those companies that are the best at hardware are the only ones capable of earning sustainable profits?

This is the first part of “Is Apple killing software biz” feature. Check back tomorrow for “Part II:  The ultimate revenge of Steve Jobs

Image credit: Pastor Seth

 

Author: Brian S Hall

Brian S Hall writes about technology, immortality and food for ReadWrite, Techpinions, Unwired View and other publications. His thoughts on the 'smartphone wars' and how these are rapidly de-constructing markets, industries, business models and relationships around the world can be found on his personal site at www.brianshall.com.

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  • http://antoinerjwright.com Antoine RJ Wright

    This article should be comparing business models and primary aims. That would be the only way to make the statement that Apple is doing it right and others aren’t. Of course, when you do this, companies like Samsung and LG make weird comparisons, because they do hardware components, which is where their profits lie, not in hardware products

  • melci

    The amusing thing is that at the same time that Amazon is selling its Kindle hardware below cost, they are also selling their ebooks below cost. Where exactly are they supposed to be making money again?
    No wonder they are in the red currently and in the past have only ever delivered slim profits.

    Then there is Google that actually makes more from iOS users than their own platform. In fact, Opera estimates that iOS makes up 47% of ad traffic and a massive 61% of ad revenue. In contrast, Android only accounts for 24% of traffic and 27% of revenue.

  • http://www.amazon.com/-/e/B002VH8ECQ Brian S Hall

    Yes, these are the kinds of numbers that inspired me to write this. If the ‘give it away for free’ strategy doesn’t kill off Apple (and Microsoft) what then?

  • Sudheer

    Apple, in long run, cannot compete with hundreds of Android manufacturers. The basic business model of Apple doesn’t work in hi-tech. That is, Apple doing everything from silicon chip to OS to apps is not a sustainable model. If Apple innovates one thing, the Android OEMs will innovate at-least 10 if not more. Also, they will offer at much, much lower price.

    It seems to me that Apple guys will never understand. They haven’t learnt any lesson from their previous failure. They are making same mistakes again, although it may take couple of years more to fail.

  • http://twitter.com/snookasnoo Idon’t Know

    You aren’t paying attention. Google is losing money on Android. All he Android device manufacturers are losing money except Samsung and they won’t say what their profits are. Apple makes amazing profits from their devices. The current Android model is unsustainable. It is also very clear you know little about Apples history.

  • http://twitter.com/snookasnoo Idon’t Know

    Their profits lie in components and products.

  • mhikl

    “Then there is Google that actually makes more from iOS users than their own platform.” melci
    Exactly, melci. So what if Apple went offensive and offered its own ‘StartPage’ like service cutting out Google through an SP-like information erasing effort. What the hey. Google sat on Apple’s board and collected data. Comeuppance is a worthy form of revenge in the art of Japanese bujutsu attack. Google could kiss its 61% revenue from iGizmos “Sayonara, baby”.

  • mhikl

    Idon’t Know, sometimes people don’t actually read articles they comment to.

  • alenart

    The “software” business is not dead by any means. Even if Google isn’t making money on Android the way Apple is making it with hardware today, Google is building up a huge amount of data about people through the use of their software. Google Now is a superior experience to Siri, and I predict this will continue to be the case. Apple did well with iTunes and their app store, but Google has a unique advantage over Apple in that they are in the search business, and became the top search engine due to things like advanced algorithms, which is software. I believe the combination of Google’s unparalleled data collection and innovation in knowledge systems, along with a long term presence in mobile will ultimately trump hardware, and allow Google to reach higher profits. There will be some way they can tie these together to make huge money. Giving a (mobile) device the ability to help someone (or influence someone) by talking them through making a large purchase will be huge, and this will be done through software.