Monday, January 29, 2007

The Meaning of iPhone, Part I

iPhone was announced, raised up as a messianic product, suffered a backlash (already, five months before it ships), and is still supplying fresh blogfodder:

First, what everyone knew from 10 seconds into the demo, is that iPhone is not a defensive move. Apple did not merely forestall what has been the oft-repeated and never realized prediction that mobile phone unit volume would inevitably crush iPod under a tide of carrier-subsidized music players. Apple is now the maker of the most desired phone on the planet.

Nobody has ever gone from zero to the very top of the game with their first mobile phone product. Expectations for the iPhone were that it would be a Very Nice Phone inside of an iPod. But only that. Instead Apple has created a new mobile phone OS and UI platform and implemented it to a level of polish above all others. They put this new software into a vessel that is, once again, the nicest package in the business. Only this time in a demanding and mature business to which Apple is a new entrant.

How much better is iPhone? Despite the very competent efforts put into mobile user interface systems like UIQ and Series 60 UI, has anyone ever really been impressed by the results? At best, users of existing products find them adequate. Inoffensive. Nice that they don't often get in the way of an important task, like reading e-mail. Meeting this standard is what Apple was expected to do. Instead they passed it from a standing start and are now in the lead.

The only knock on the iPhone is that it does nothing new, other than provide a visual interface to voicemail. But even that modest advance was a zinger. Handset product managers world-wide are dope-slapping themselves for not pushing that through in the fifteen years since that has been technologically do-able.

But this is Apple: Making the object of desire is just the start. Apple also took the challenging environment for selling a mobile phone into the U.S. Mobile network operators' channel and turned it into a work of art comparable to the iTunes contract negotiations.

By giving a willing network operator the temporary advantage of exclusivity, Apple got at least two critical benefits: Apple set terms that drive a wedge into the garden wall of mobile content sales by keeping iTunes sales off the mobile network. Apple also got the benefit of not having the iPhone subsidized by the network operator. That's correct – the benefit. In both cases one imagines the negotiations to have gone a bit like asking not to be thrown into the brier patch.

By keeping iTunes sales off the mobile network Apple completely hornswoggled Cingular. Cingular is a network operator. So who came off worse: Apple, for having to require that their customers use WiFi to download iTunes purchases? Or Cingular for having failed to sell the use of their network for this purpose? Cingular has ripped a hole in the wall in order to get that big wooden horse inside. Users of Nokia E-series handsets already know the real Web over WiFi is a much nicer experience than the mobile Web. Now millions of Cingular users will be comparing the iTunes over WiFi experience with the typical mobile content shop experience.

Which leads to the next issue: Why would Cingular subsidize an iPod, especially when it isn't using Cingular's network? Turns out they don't have to. Which also frees Apple from the prospect of music-only iPods competing against subsidized iPhones, and from mobile network operators using varying levels of subsidy, resulting in a range of iPhone prices, once the term of exclusivity expires. No subsidy also makes it easier for Apple to sell iPhone in Apple stores.

Keep in mind that MNOs' executives had not seen the iPhone. The only precedent they had to work with was the first iPod, which was hardly a revolutionary looking device. In agreeing to terms that appeared to be solutions to some practical problems when they were negotiated, they gave Apple the levers to move the mobile handset business in directions advantageous to Apple. As in the case of Blackberry subscription revenue, the mobile industry is willing to shift on some fundamental points of the handset vendor relationship if the handset brings with it significant end-user demand. But unlike Blackberry, it wasn't just a matter of revenue sharing.

It took two years for iPod to gain momentum. Analysts project that iPhone will take 1% of the mobile phone market fairly quickly. If sales fall into the range of 5 to 15 million units over 12 months Apple will roughly match their only near-direct competitor: Nokia Nseries, which sold 6 million units last quarter. In about two years Apple will have a product line as broad as Nseries, and could take 5% of the mobile handset business, and a really hefty chunk of the total profits, since Apple won't be selling any low-end handsets.

Are Cingular chumps for agreeing to these terms? Not really. They will look like geniuses for seizing what will be one of the very few opportunities to move a couple million subscribers to their network. The strategic impact of iPhone on the mobile industry will only be felt once the product exists in millions of units, and it will be spread throughout the industry. Apple will be free to set pricing of handsets, and will be free to operate a parallel commerce channel on a parallel network. No other handset maker has ever taken as much away from a negotiation. Even Qualcomm would be jealous of that kind of leverage.

What about the impetus – defending against mobile phones that are also media player? It sure looks like iPhone is a solid defense. But is there really a threat to defend against? Apple will sell more than 100M iPods in 2007. That is about one tenth the number of mobile phones that will be sold. The iPod market is now too big to be “crushed.”

Those engaged in building a mobile phone-based music business will have to contend with a fragmented handset technology and m-commerce landscape. Only Qualcomm and, perhaps, Nokia have control over enough of that landscape to mount a challenge, and to do it comprehensively from e-commerce channel to handset. On top of that, a mobile music challenger will have to use the mobile data network to deliver content of similar quality to that available on iTunes. And on top of that the prices will have to meet iTunes prices. Being able to buy on the go, out of WiFi range, just isn't enough to justify a higher price.

By the time a mobile music challenger really gets going, Apple will have new iPhone models on the market, and will be on the way to taking 5% of the mobile handset business and not just defending itself against the mobile music business, but being the mobile music business.

Wednesday, January 03, 2007

A Brittle Monopoly, a Fragile Revolution

Vista will have a broad-based launch soon. Unlike the launch of Windows XP and Windows 95, buyers won't be lining up outside stores to get the first copies. Vista is late, and Vista benefits are uncertain. This uncertainty was not helped by Microsoft's longstanding and widely publicized fascination with DRM – the benefits of which were seen by customers as ranging between dubious and toxic.

The other recent Microsoft product launch – the Zune – did not add to Microsoft's momentum. Zune is a geeky, awkward device that adds DRM to your own rips. It is promoted by an ad campaign with an obscure and awkward strap line that feels like something out of a “your brain on drugs” ad. And then there is the “squirting.” Oh, the squirting.

With all the bad news about Microsoft, you might be shocked to find statistics that say that 90% of the installed base of PCs are running various versions of Windows.

One can argue that the number is flawed. But the numbers that all add up to around 90% come from various sources, with diverse methodologies, such as retail sales and Web-site visitors. So 90% can't be attacked as a static measure, or one that is skewed by showing only one kind of computer user.

Another measure that suggests a near-monoculture of Windows is that viruses and spyware are almost exclusively targeted at Windows. Or, look at a catalog: Even the catalog of a “hobbyist-friendly” outfit like Micro Center has, maybe, 3% of desktop PCs with Linux. The rest run Windows. 0% of laptops come with Linux installed.

All indications are that personal computing still at the very narrow end of the wedge of restoring diversity in end-user operating systems. This is a movement that could be crushed or turned back. It certainly has not become strong enough that it is certain to survive.

However, when change comes, it will be sudden. Either Linux will be banned as too subversive for society, law enforcement, and content publishers to tolerate outside of Web servers and embedded applications, or Windows will precipitously fall from its position of near monopoly in the installed base of client operating systems, driven into retreat by the polish of Apple's MacOS and the freedom and democracy of open source.

The reason that change will be abrupt is that the Windows monopoly is brittle. It is brittle because it is based on hegemony in licensing to manufacturers, and on taking the content publishers' side in promoting DRM even as publishers become more strident, restrictive, rent-seeking, and litigious in their view of how content can be used by consumers.

This isn't the road to general popularity, much less is it the way to keep opinion leaders on your side. Any customer that is smart enough to be aware that their computer is going to rat them out to content publishers (and who knows who else) resents it. While most consumers are unaware or apathetic, opinion leaders are almost uniformly against DRM. Microsoft failed to grasp early opportunities to show DRM could be used to secure users' documents against misuse. That might have shifted the argument to something closer to a balance, but as it is, DRM is purely a source of resentment, without identifiable benefits.

Microsoft also appears to have a tin ear for the resentment against DRM. Apple is praised for pushing DRM mostly out of sight, while Microsoft is in the news for completely embracing DRM to the extent it is fundamentally changing the nature of a personal computer from a machine the user controls completely to one that is outfitted for surveillance and control by publishers (and who knows who else).

But all that does not mean that the Forces of Good will triumph. It does mean that the conflict over free and open software will be sharp and full of rhetoric about how free and open software is the tool of drug kingpins, terrorists, and pornographers. This rhetoric, and laws that make general purpose computing and communication tools contraband, will be used against free and open software. It will be used to hang the threat of liability over computer makers in order to maintain license hegemony.

Is Microsoft's share price stagnation and Microsoft's position for DRM linked? Before answering that, let's also ask if there was a different corporate culture at Microsoft when it was in ascendancy.

Microsoft's success was based on providing an inexpensive, off-the-shelf computing system that was good enough to replace many expensive minicomputer and mainframe systems that held customers hostage to high maintenance fees charged by hardware and software vendors. For those who could not afford minicomputers, Microsoft's software used to be the tool the little guy could use to level the playing field.

When Microsoft was on the way up, they were breaking eggs and making omelets. They were making other companies' products obsolete, and delivering high value, and driving companies like Wang, Digital, and Data General out of business. Now they are in the business of preventing the RIAA and MPAA dinosaurs from shuffling off to the tar pits, preventing corporate computer users from doing anything their IT department does not approve of, and preventing you from knowing everything going on inside your computer. That is, Microsoft has gone from selling creative destruction, to preserving obsolete business models, corporate IT controls, and facilitating content publishers' and others' intrusions into your use of information.

Does this mean Microsoft is doomed? No. Microsoft has thriving businesses in appliance devices like mobile handset software and game consoles where customers do not expect – yet, anyway – to have full control over the device. Microsoft's Office Communications Server is a dagger at the heart of the PBX business, and very much fits the model of the ascendant Microsoft. These parts of Microsoft will grow rapidly in the coming years.

It does mean Microsoft is in a vulnerable position on the consumer desktop. Like GM that can't compete with BMW quality or Hyundai price, Microsoft Windows is becoming a product only for those that don't care about having something better: Apple will be the choice of customers that can afford Apple, and Linux will be choice of those that value a true personal computing experience. Microsoft will be left with the sort of people who still buy Buicks. On top of that, depending on the extent to which DRM becomes visible to end-users of Vista, Windows will also become a product for people who don't care about not having Big Brother Inside. That may sound like an extreme comparison, but there was just recently a time when it seemed like GM could go on selling Buicks forever, too.

To really turn itself around and gain a path to new growth, Microsoft has to say no to the content publishers and say yes to end-users' concerns about privacy and control over computers and content they buy. But I don't expect Microsoft to do that until the message is written in declining market share and further stagnation of the company's value.