Apple Risks Dominant Position in Tablets With New Digital Publishing Model

The battle between Apple and Google intensified this week with both companies unveiling long awaited business models for publishers eager to develop recurring revenue sources through sale of tablet based subscriptions.

Apple’s service imposes more onerous terms on publishers compared to Google’s “One Pass” service and severely restricts the information publishers are likely to collect from customers.  For Apple and Google, the stakes in this battle are far higher than developing incremental revenue sources from these digital publications.  The winner is likely to gain dominance in tablet operating systems for the foreseeable future.

Very Different Terms

Apple plans to charge publishers 30 percent of revenue from all sales processed through the App Store which is consistent with the revenue share Apple receives from application developers.  Publishers will be permitted to sell subscriptions to customers through other channels such as the publisher’s website but will be prohibited from offering any discounts to customers who bypass the App Store.  In addition, Apple will not provide any customer data to publishers unless the customer specifically opts in.

Google will take a 10 percent cut of revenues for subscriptions purchased through the “One Pass” service and claims that this revenue is essentially covering its costs for managing the process and not intended to be a profit generator.  Google will also provide customer information to the publisher unless the customer opts out. There is no information to indicate that Google plans to prohibit publishers from offering discounted subscriptions for customers who bypass the One Pass service.

Subscriber Data is Critical for Publishers

While the revenue share is the most obvious difference in terms, the more important restriction imposed by Apple involves the customer data.  There has always been a major distinction between “single copy” sales and subscription sales from a publisher’s perspective.  The customer who picks up a physical copy of The Economist at a news stand is entirely anonymous.  The subscriber to The Economist is always known to the publisher.

Most publishers allow customers to opt out of solicitations for products or services, but the key point is that all publishers use subscriber lists to directly solicit renewals.  By depriving publishers of the customer data, Apple seeks to keep the customer anonymous and increases the probability that future renewals will be processed through the App Store rather than through a direct transaction between the publisher and the subscriber.

Essentially, Apple seeks not only a “finder’s fee” for bringing the subscriber to the publisher in the first place, as is typical with many agency relationships, but aims to develop a recurring revenue stream in which renewals are processed through the App Store.  It is far more likely that this goal is behind Apple’s “opt-in” model for providing customer data to publishers than any idealistic notion of customer privacy.

Window of Opportunity Closing Fast

Apple’s iPad is currently the market leader in terms of market share as well as capabilities but a flood of Android based tablets will appear on the market over the next six months.  If Apple’s current dominance in tablets convinces publishers that they must go along with Apple’s terms, and if Apple can release a competitive iPad 2 this spring, it is very likely that Apple’s dominance can continue.  The main reason is that customers are attracted to the iPad not only because of the hardware and operating system capabilities but because of the content offered by third parties.

Apple must be hoping that enough publishers will agree to make subscription content available within the next few months due to the iPad’s current dominant market share.  When the iPad 2 is released and must compete with newly competitive Android tablets, Apple’s goal should be to not only have the best hardware and software but also the most comprehensive array of publications on the  market.  If this goal is met, Apple’s market share should hold up well because customers will gravitate toward the content.

On the other hand, if Apple has overreached, publishers may decide that it is worth moving forward with Android based tablets in anticipation of much more competitive products coming to market in the near future.  If a larger array of publications are available on Android devices, Apple’s market share will be pressured even if the iPad 2 retains a technological lead over the new generation of Android based tablets.

High Stakes Gamble

Apple may have been better served by offering less onerous terms to publishers particularly related to customer data.  Doing so would virtually guarantee that publishers would gravitate toward the Apple ecosystem due to its current market dominance and would result in the widest possible selection for users.  Apple would still have to retain its technological lead with the iPad 2 given the advances in Android based devices, but it would likely be secure in having a lead in content availability.

The decision to impose harsh business terms on publishers has increased the uncertainty regarding how the tablet wars will play out over the course of 2011 and may help Android based devices gain additional traction.

Disclosure:  No position in Apple or Google.

Nokia’s ‘Burning Platform’ Highlights Perils of Creative Destruction

When the Nokia 6160 cellular phone was released in the late 1990s, it was one of the hot technology gadgets of the era.  With its “candy bar” styling, good looks, and positive user experience, the phone was very popular and was once considered something of a minor status symbol.

Fast forward one decade and many of the same observations could have been made about early versions of Apple’s iPhone which first appeared in 2007.  The iPhone has only increased in popularity with each new release over the past four years but may have lost some of its allure as a status symbol now that it seems like almost everyone has a smart phone.  Google’s Android operating system has made great strides and poses formidable competition for Apple.  Nokia, on the other hand, has a “burning platform” that is in decline.

Cling to Burning Platform or Jump into Icy Waters?

In a memo intended for Nokia employees, CEO Stephen Elop has characterized Nokia’s current plight in stark terms.  Mr. Elop recounts the events of the past four years since the introduction of the iPhone and notes that Nokia has steadily fallen behind competitors despite what he characterizes as “brilliant innovation” within the company.  At the core of Nokia’s problems is the dated Symbian operating system which fails to deliver the user experience of modern smart phones and is now losing ground in lower end devices as Google’s Android operating system begins to penetrate the market for sub-$100 phones:

At the midrange, we have Symbian. It has proven to be non-competitive in leading markets like North America. Additionally, Symbian is proving to be an increasingly difficult environment in which to develop to meet the continuously expanding consumer requirements, leading to slowness in product development and also creating a disadvantage when we seek to take advantage of new hardware platforms. As a result, if we continue like before, we will get further and further behind, while our competitors advance further and further ahead.

Nokia appears to be “stuck in the middle” to use Michael Porter’s characterization of firms that have failed to distinguish themselves as cost leaders or as differentiators of premium products.  Such firms typically achieve mediocre business results but in the case of a technology company in a rapidly changing field, the result is more likely to be eventual extinction without taking steps to radically change:

We poured gasoline on our own burning platform. I believe we have lacked accountability and leadership to align and direct the company through these disruptive times. We had a series of misses. We haven’t been delivering innovation fast enough. We’re not collaborating internally.

Nokia, our platform is burning.

Sometimes a company needs a pep rally from its leadership and sometimes a stern dose of reality is required.  Mr. Elop has chosen to deliver the required message.  On February 11, Mr. Elop is scheduled to make a major presentation regarding Nokia’s future direction and all signs point to the company’s adoption of an alternate operating system such as Android or Windows Phone 7.

Creative Destruction and Apple

Apple has become a favorite investment for growth and value investors alike and today’s valuation does not appear demanding particularly when the market capitalization is adjusted for excess cash on the balance sheet.  We have been critical of Apple’s poor level of disclosure regarding the health of CEO Steve Jobs but no one can deny that the company has delivered stellar financial results for shareholders and this has been reflected in stock price performance.

The bullish case for Apple recognizes the company’s proven innovation and implicitly assumes that such performance can be sustained in the future.  This may be a dangerous assumption given the unfortunate reality that Mr. Jobs may not remain at the helm for the long term.  Although Apple has solid operational and technological talent, few doubt that Mr. Jobs has provided much of the vision behind groundbreaking products like the iPhone and iPad.

Which Phone Will You Use in 2020?

Even with continued technological excellence, Apple is subject to the forces of creative destruction just like any consumer electronics company.  In 1998, users of Nokia’s 6160 cell phone held in their hands the best that money could buy in terms of mobile communication and the same may be true for today’s iPhone 4 user.  Few, however, would hazard a guess regarding what type of cell phone (or, in reality, pocket computer), people are likely to favor in 2020.  The same is true of tablet devices and other consumer electronics devices.

We do not pretend to be able to forecast the future for Apple but at some point, the company could face the “burning platform” issue that no one thought Nokia would face when the company’s technology was “state of the art” not so long ago.  In more mundane fields, Schumpeter’s notion of creative destruction can work at a slower (and sometimes glacial) pace but in consumer technology a decade is an eternity.  This is something that Apple shareholders must seriously consider.

Disclosure:  No positions.

With Jobs on Medical Leave, Apple Shareholders Deserve More Disclosure Regarding Succession

In a letter to Apple employees released Monday morning, Steve Jobs informed his team that health issues have forced him to take a leave of absence from his day-to-day duties as CEO of the company. Tim Cook, who capably managed Apple in 2009 when Mr. Jobs had a lengthy medical absence, will again assume responsibility for day-to-day operations. Mr. Jobs will remain involved in “strategic decisions” for the company. No time frame was given for Mr. Jobs to return on a full time basis.

While Apple shareholders and customers no doubt wish Mr. Jobs a speedy recovery, the present situation bears an uncomfortable similarity to the events that unfolded almost exactly two years ago. On January 5, 2009, Mr. Jobs announced that a “hormone imbalance” that led to significant weight loss necessitated a leave of absence and that he did not wish to elaborate further on the condition. One week later, he indicated that the situation was “more complex” than anticipated and required a six month leave.

Rumors of the nature of Mr. Jobs’ illness immediately spread like wildfire and anonymous sources were quoted in articles indicating that a liver transplant may be required. At the time, Mr. Jobs refused further comment telling Bloomberg reporters “Why don’t you guys leave me alone–why is this important?”. Months later, sources confirmed that Mr. Jobs had indeed received a liver transplant. He returned to Apple in June 2009.

Is this level of disclosure adequate?

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Disclosure:  No position in Apple.