Wednesday, July 16, 2014

Upstream vs. downstream complementarities in Apple-IBM deal

Despite coverage to the contrary, Tuesday's announcement that IBM will help sell Apple products to enterprise customers is long overdue and merely the latest example of cooperation between the firms spanning more than two decades.

The new thing is that — unlike previous deals — the cooperation announced by Apple CEO Tim Cook and IBM CEO Virginia Rometty reflects downstream complementarities rather than upstream ones.

In their seminal book Co-opetition, Brandenburger and Nalebuff defined complementarity between products X and Y as meaning that if someone bought X, then Y would be more valuable (and vice versa). This basic principle is behind nearly any positive-sum (“win-win”) strategic alliance today.

Yes, Apple’s early successes began to fade when IBM introduced its PC in August 1981, and its 1984 Macintosh introduction was aimed squarely at Big Blue and its user-unfriendly DOS PC. But the two companies have been cooperating far longer than they competed, largely through their cooperation in upstream components.

The big cooperation surprise came not in July 2014 but October 1991. Then Apple CEO John Sculley and IBM President Jack Kuehler announced that Apple would be using PowerPC CPUs based on IBM's proprietary RISC chips (Motorola was the third partner in the alliance).

At the same time, Apple and IBM launched two Silicon Valley-based software joint ventures based on a common rivalry with Microsoft. Taligent nearly killed Apple (and thus helped me find a new career) by siphoning off Apple’s top engineers to work on an operating system that it never shipped. Kaleida was intended to solve CD-ROM scripting challenges, but was swept aside by the emergence of Java and the commercial Internet.

A few years later — at the depth of Apple’s self-inflicted slide towards irrelevance — IBM helped Apple with problems creating hardware in its fastest-growing and most profitable segment, laptop computers. It sold its unique laptop hard disk to Apple (but not to HP) and also built the 1997 PowerBook 2400c for Apple at its IBM Japan division.

Fast forward to the 21st century. IBM could have begun selling Apple's hardware at any point since it divested its PC division in 2005. This is exactly why the company exited the market segment that it had created 24 years earlier: to get rid of a low-margin commodity hardware business and give it more flexibility to sell higher-margin integration services to large corporations.

The question is: what took them so long? The iPad came out in April 2010 and Steve Jobs has been gone for nearly three years. Ever since the Macintosh (1984) and particularly the LaserWriter (1985), Apple has been making products that would appeal to large companies, but lacked the sales, support and integration capabilities needed to address their customer’s complete requirements. (Only us Mac graybeards remember the 1988 Apple/DEC alliance that was intended to address these problems.)

Today, the two companies are not just looking over their shoulders at Microsoft, but also Google as well. The iPhone and iPad have already been widely adopted in big companies — spawning the IT acronym BYOD — but the new alliance should (like other successful downstream complementaries) generate incremental revenue growth for both parties.

However, there was one glaring omission in the latest Apple-IBM collaboration announcement: cloud computing. Apple has a retail presence with its true believers that is central to its integration strategies, but lacks the scale to compete with the industry leaders, Amazon and Google. IBM is their major competitor as a wholesale supplier, but (unlike Amazon and Google) does not compete with Apple’s retail offerings.

In the long run, Apple will unable to go it alone in cloud computing. We’ve all seen the risks that companies take relying on Amazon (cf. Netflix) or Google (cf. Samsung) as a supplier who is also a competitor. As in the PowerPC days, Apple should not only be leveraging IBM’s scale but working to attract others to its platform as the last honest broker in cloud computing.

Sunday, July 13, 2014

Nation-states, city-states and the World Cup

Productivity the world over will improve starting tomorrow with the end of the 2014 World Cup. ESPN and Nike will celebrate the unprecedented interest by American TV viewers, buoyed in part by the unexpectedly long run by Team USA.

Within Europe (at least outside of Russia) national rivalries are fought on the football field and not the River Somme, Ardennes Forest, or Fulda Gap.

Unlike in the Olympics, success seems only imperfectly correlated to depth of talent or national resources. None of the world’s 10 largest countries made it into the championship, although Brazil (#5) earned 4th place and USA (#3) made it to the round of 16. The top country in Europe (Germany) was the largest, but the top country in South America was only the 3rd largest (Argentina, with 10% of the population vs. 49% for Brazil).

But before there were nation-states, Europe in the Middle and early Modern period of Europe was organized as city states. In many cases, they were small principalities organized around a capital (like Monaco and Liechtenstein today). Even in today's German republic, three of the 16 Länder are historic city-states (Berlin, Hamburg and Bremen).

Norman Jewison’s dystopian 1975 movie Rollerball imagined a world when nation-states were gone and rivalries were channeled through city-states. The hero (James Caan) and his Houston team have a violent match against Tokyo that leaves his best friend brain-dead, the brutal climax of the movie comes when Houston fights New York in a match that ends with only Caan left standing.

While the German players tonight are exulting and the Argentineans (and Brazilians and Belgians and Americans …) are heartbroken, for most of the next 47 months their allegiance will be to the city- rather than nation-state in their full-time (professional) sports careers.

Finals hero Mario Goetze and Golden Glove winner Manuel Neuer plays for Bayern München, but World Cup record holder Miroslav Klose plays for Lazio in the Italian Serie A league. Meanwhile, Mesut Ozil and Per Mertesacker play for Arsenal in the English Premier League. Arsenal also lists players for Belgium, Costa Rica, England, France, Spain and Switzerland. For archival Manchester United, Robin van Persie scored the winning goal for the Netherlands 3rd place finish, with other players playing for France, Mexico, Japan and Portugal. ManU also provided Team USA’s record-setting goalie, Tim Howard.

Despite (or because) of their common position in the English Premier League, Arsenal fans have no more love for ManU than American baseball fans outside NYC have for the Yankees. (Germans are similarly divided between those who love Bayern München and those who detest the team and its fans).

So for less than 5% of every four year cycle, European soccer fans are rabid nationalists, and the rest of the time they are loyal to their local city-state. In some ways, we are well along are way to Jewison’s vision (but hopefully not the dystopian part).

Note to readers: apologies for not blogging recently, but due to travels, office meetings and research deadlines (including WOIC 2014) I’ve been unable to finish several posts during the past month.

Tuesday, May 27, 2014

Fractalization (and trivialization) of technological innovation

My friend Frank Piller this morning shared a witty story from last week’s New Yorker. The title and subtitle say it all:

“Let’s, Like, Demolish Laundry”
Silicon Valley is in a bubbly race to wash your clothes better, faster, and cooler. This is not a metaphor. Unless, you know, it is.
The story about IT-enabled laundry delivery services focuses on Washio, a LA-based seed-funded startup. The three founders cruise along confident in the brilliance of their idea until they run across three Bay Area rivals (Laundry Locker, Prim, Rinse) — one incubated by Y Combinator — and eventually five more from NYC and two from Chicago.

Author Jessica Pressler makes only a feeble effort to restrain her sarcasm. In commenting why so many other tech entrepreneurs are addressing the same need:
In reality, when people in a privileged society look deep within themselves to find what is missing, a streamlined clothes-cleaning experience comes up a lot. More often than not, the people who come up with ways of lessening this burden on mankind are dudes, or duos of dudes, who have only recently experienced the crushing realization that their laundry is now their own responsibility, forever. Paradoxically, many of these dudes start companies that make laundry the central focus of their lives.
But even in this segment, “new innovations are dying from the day they are born… There’s a term for this. It’s called the hedonic treadmill.”

Some of it has an anthropologist-visits-the-strange-tribe-of-Silicon-Valley feel. Even though their main office is in Santa Monica, Washio has the same (post-Amazon) disrupting of the physical world that brought us Pets.com and Uber. Their goal is to be “the Uber of laundry," and their share a common seed stage investor.

But early on, Pressler raises a more fundamental question:
We are living in a time of Great Change, and also a time of Not-So-Great Change. The tidal wave of innovation that has swept out from Silicon Valley, transforming the way we communicate, read, shop, and travel, has carried along with it an epic shit-ton of digital flotsam. Looking around at the newly minted billionaires behind the enjoyable but wholly unnecessary Facebook and WhatsApp, Uber and Nest, the brightest minds of a generation, the high test-scorers and mathematically inclined, have taken the knowledge acquired at our most august institutions and applied themselves to solving increasingly minor First World problems.
Certainly Amazon and Google and Facebook (mostly) allow us to do things we did before, just more quickly and cheaply and conveniently. Yesterday, my sister-in-law could have mailed pictures of her daughter’s graduation to her friends and relatives, but instead she posted them on Facebook and they were instantly available.

Like Pressler, many of these activities seem trivial when I compare this to other “big” innovations, like trying to get mankind back into space or provide enough food and energy to bring 5 billion of the world’s 7 billion people up to developed world living standards. After changing jobs three years ago, life at my new employer reminds me that the life sciences have many important unsolved problems, whether it be preventing deaths from malaria and tuberculosis in sub-Saharan Africa or finding a cure for cancer.

But on another level, Pressler’s article would come as no surprise to my innovation strategy students of the past eight years (whether at KGI, UCI or SJSU). The pattern is straight out of Dealing with Darwin, the grand unified theory of innovation by Geoff Moore (best known for Crossing the Chasm).

One reason I use the book is that it offers a cogent explanation of the role of innovation in mature industries. He subdivides such innovation into two categories, operational excellence (cheaper) and customer intimacy (better). For the latter, he uses the metaphor of “fractalization”, as illustrated by this diagram from Chapter 6:
As Moore explains (p. 111-112)
Figures 1 through 3 represent the early, middle, and late stages of a growth market. ... As the figures indicate, the driving dynamic at this point is a single-minded attempt to acquire new customers and claim market share.

By the time we hit figure 3, however, the market for the basic offering has become saturated. One can no longer grow simply by adding new customers to the category because the bulk of them have already been added. After virtually every home has a phone, every garage a car, every child a personal sound system, what do you do next?

Thus, from the mass-market Model T car, for example, the automotive industry first generated line extensions: a sedan, a station wagon, a truck, a couple, a limousine.

Increasingly fine-grained fractalization can and will continue as long as there are discretionary dollars to spend in the system and the category as a whole has not become obsolete.
We do need to recognize the contributions of the laundry app innovators (even if they go the way of the sock puppet). By moving the realm of innovation from the physical world to the digital world, they are enabling new form of experimentation and innovation — as happened in retail, communications, advertising, journalism and other established industries.

Pressler makes clear that the laundry apps still depend heavily on their contract laundry suppliers who do all the work. But if such apps catch on, it would seem obvious that the laundry market will be rapidly consolidated, with the tiny corner dry cleaners replaced by a handful of regional factories. One would expect (as with Web 1.0 and 2.0) the adoption will be most rapid in Silicon Valley, with the shops in Palo Alto or SoMa served by ecofriendly delivery trucks driving from large plants in Morgan Hill or Livermore.

Tuesday, May 13, 2014

Why some fear Google -- and others should, too

Excerpts from a 4,000 word letter by the CEO of a leading German publisher to the company that once promised “don’t be evil”:

An open letter to Eric Schmidt
Why we fear Google
17.04.2014, von MATHIAS DÖPFNER
Frankfurter Allgemeine
Dear Eric Schmidt,

In your text “Die Chancen des Wachstums” (English Version: “A Chance for Growth”) in the Frankfurter Allgemeine Zeitung, you reply to an article which this newspaper had published a few days earlier under the title “Angst for Google” (“Fear of Google”). You repeatedly mention the Axel Springer publishing house. In the spirit of transparency I would like to reply with an open letter to highlight a couple of things from our point of view.


Google doesn’t need us. But we need Google
Google’s employees are always extremely friendly to us and to other publishing houses, but we are not communicating with each other on equal terms. How could we? Google doesn’t need us. But we need Google. And we are also worlds apart economically. At fourteen billion dollars, Google’s annual profit is about twenty times that of Axel Springer. The one generates more profit per quarter than the revenues of the other in a whole year. Our business relationship is that of the Goliath of Google to the David of Axel Springer. When Google changed an algorithm, one of our subsidiaries lost 70 percent of its traffic within a few days. The fact that this subsidiary is a competitor of Google’s is certainly a coincidence.

Not only economic, but also political

We are afraid of Google. I must state this very clearly and frankly, because few of my colleagues dare do so publicly. And as the biggest among the small, perhaps it is also up to us to be the first to speak out in this debate. You wrote it yourself in your book: “We believe that modern technology platforms, such as Google, Facebook, Amazon and Apple, are even more powerful than most people realize (...), and what gives them power is their ability to grow – specifically, their speed to scale. Almost nothing, short of a biological virus, can scale as quickly, efficiently or aggressively as these technology platforms and this makes the people who build, control, and use them powerful too.”

The discussion about Google’s power is therefore not a conspiracy theory propagated by old-school diehards. You yourself speak of the new power of the creators, owners, and users. In the long term I’m not so sure about the users. Power is soon followed by powerlessness. And this is precisely the reason why we now need to have this discussion in the interests of the long-term integrity of the digital economy’s ecosystem. This applies to competition, not only economic, but also political. It concerns our values, our understanding of the nature of humanity, our worldwide social order and, from our own perspective, the future of Europe.

The greatest opportunity in the last few decades

As the situation stands, your company will play a leading role in the various areas of our professional and private lives – in the house, in the car, in healthcare, in robotronics. This is a huge opportunity and a no less serious threat. I am afraid that it is simply not enough to state, as you do, that you want to make the world a “better place.”

You say in your article that those who criticize Google are “ultimately criticizing the Internet as such and the opportunity for everyone to be able to access information from wherever they happen to be.” The opposite is true. Those who criticize Google are not criticizing the Internet. Those who are interested in having an intact Internet – these are the ones who need to criticize Google.

Google is to the Internet what the Deutsche Post was to mail delivery or Deutsche Telekom to telephone calls. In those days there were national state monopolies. Today there is a global network monopoly. This is why it is of paramount importance that there be transparent and fair criteria for Google’s search results.

However, these fair criteria are not in place. Google lists its own products, from e-commerce to pages from its own Google+ network, higher than those of its competitors, even if these are sometimes of less value for consumers and should not be displayed in accordance with the Google algorithm. It is not even clearly pointed out to the user that these search results are the result of self-advertising. Even when a Google service has fewer visitors than that of a competitor, it appears higher up the page until it eventually also receives more visitors. This is called the abuse of a market-dominating position. And everyone expected the European antitrust authorities to prohibit this practice. It does not look like it will.

Is it really smart to wait?
Historically, monopolies have never survived in the long term. Either they have failed as a result of their complacency, which breeds its own success, or they have been weakened by competition – both unlikely scenarios in Google’s case. Or they have been restricted by political initiatives. IBM and Microsoft are the most recent examples.

Another way would be voluntary self-restraint on the part of the winner. Is it really smart to wait until the first serious politician demands the breakup of Google? Or even worse – until the people refuse to follow? While they still can? We most definitely no longer can.

Sincerely Yours
Mathias Döpfner
Via John Paczkowski at re/code

Sunday, May 11, 2014

Apple's curious acquisition

Apple’s reported efforts to buy Beats Electronics for $3.2 billion have been the subject of endless speculation since it was first reported Thursday. We don’t know Apple’s actual reason for interest — or even if the deal will happen — since Apple has yet to make any official announcement. (As with all such leaks, this leak seems intended to influence the deal — presumably by the sellers to force Apple to follow through.)

Certainly this is out of character for Apple, since its largest previous deal was $0.4 billion to buy NeXT, the basis of its OS X. But the press frenzy about how precedented the deal is seems a bit exaggerated. After all, there’s always a first time for anything, including its successful acquisitions such as the purchase of NeXT, PA Semi, and Siri. (Google got a lot of flack in 2006 for spending $1.65 billion to buy YouTube).

Is the acquisition a good idea? When we (i.e. strategy professors) teach related diversification by acquisition, there is a standard list of pros and cons.

On the pro side, an acquisition is usually about time to market — accomplishing something more quickly than you could do on your own. It can acquire technology, customers, distribution, products and people. For the latter, Silicon Valley normally thinks in terms of engineers. However, an acquisition can also bring new executives: the NeXT purchase brought in the new management team of Apple — not only Steve Jobs, but essentially it’s entire management team other than the CFO that Gil Amelio installed (Fred Anderson) and the COO Jobs stole from Compaq (Tim Cook).

Finally, there is the opportunity for the newly acquired company to be more successful under its new owner than as a stand-alone company. This might be due to better management, better distribution or more available capital. For example, in our recently completed business plan competition at KGI, most of the proposed startups would sell out to a large pharma or biotech company before bringing products to market, rather than build a global retail sales force from scratch.

On the con side, there is the question of strategic fit: do the new assets fit with the organization, how will the products, people and culture be integrated — and are the business models compatible? The post-acquisition integration can be a huge distraction (but usually when buying a larger company, as with Microsoft-Nokia, Oracle-Sun or HP-Compaq).

And with any acquisition, there’s always the risk of over-paying. Perhaps the assets are valuable, but CEOs have a tendency to overpay — whether to put their mark on their company, grab the headlines or just to run a larger company.

In Beats Electronics, Apple is buying two lines of business. One is Beats by Dre, the headphones division that has nearly two-thirds (61.7%) of the US premium headphone market — nearly 3x that of Bose, which created the segment.

It’s a monstrously successful brand, but there’s little technology there. The two music industry execs who formed Beats outsourced their initial headset design to the father-son team that runs Monster Cable Products (which, lacking negotiating savvy, failed to get an equity stake in the venture they helped create). The success of the company (even more so than for Bose) is based on marketing rather than technology:

"They certainly don’t need the headphone company, which makes second rate headphones based on marketing," says music industry analyst Bob Lefsetz. He thinks Apple would be a lot more interested in Beats’ music streaming service. Steve Jobs famously opposed the subscription music model and, instead, championed iTunes' current model, where you buy a song outright.
This points to its other line of business. The nascent Beats Music steaming service leverages the value of the Beats brand with teens, but (like Apple and Amazon) is far behind market leader Spotify.

By one standard, Apple is certainly overpaying. The company’s exponential growth is not sustainable and its revenues are less than $2 billion. As a company with little technology and strong emphasis on style and brand, Beats is essentially a fashion company. Any fashion acquisition is a risky acquisition.

Will Beats by Apple seem as authentic or appealing to teens as Beats by Dre (when Dre was still the owner)? For that matter, how many fashion companies are able to sustain their position of a period of decades? In my adult lifetime, I can only think of one firm that has been successful: Nike.

Which brings us to the final possible value of Beats. The company has shown it has been able to understand teen fashion and create markets that didn’t exist. Is that because of the cofounders, Dr. Dre (aka Andre Romelle Young) and music mogul Jimmy Iovine? Or is there a depth of marketing — both market sensing and market creating — within Beats that could help Apple better sell unnecessary luxuries to middle class teens and college students?

Although it’s a large deal for Apple, it’s essentially a minor bet — hardly on the scale of Google buying YouTube or WhatsApp, let alone Microsoft’s purchase of Nokia.. Apple has more than $150 billion in cash (mostly offshore), and has few other options to create meaningful growth. With annual revenues of more than $170 billion, the Beats sales would not be material to Apple any time in the near future — if ever.

So if Apple gains an additional window into the soul of the 13-25 year-old set — or rebuilds its foothold in the music industry — then the deal could prove to be a shrewd one. As it is, it’s a gamble — but Apple didn’t get to where it is without taking gambles (such as the iPhone). It may be Tim Cook’s largest gamble to date, but it won’t be the last one he takes as CEO.