Will You Buy A(nother) iPhone

Another iPhone is on its way, or perhaps even two models[1]. And this much we already know: you will buy a(nother) iPhone. This matters, both because of the simple statements about this vast market, and because of what it says about innovation and growth in years to come.

Really, and the theme of this piece, there are four basic reasons why most people will end up buying a(nother) iPhone; its Star effect; the learning curve benefits of the iPhone’s position; the virtuous cycle of learning how users interact with their smart phones; and the business model strength. We’ll discuss each of these. Another post will deal with the opportunities to challenge Apple’s market dominance.

Here are the major forces. They are industry forces and individually they are NOT why you will buy another iPhone. Most consumers are blithely unaware of these forces and can cogently argue that they have no direct impact on their buying decisions. But together, they put Apple in a position where its phones are - or are perceived as - market leaders, and these forces sustain Apple in that position, sustain its market dominance, and its pipeline of innovation. And thus, it is these forces that assure that, for many, many customers, their next phone will be an iPhone.

1. The Star effect

This is the economic factor, well described by Sherwin Rosen and others, in which a single product or service (or person!) in a market becomes so good, so widely accepted as good, that most potential customers can decide – by themselves, and considering ‘peer-pressure’ … there’s no need to look anymore.

This factor clearly applies to a lot of retail food and drink and fast-food categories: Starbucks simply is good enough for most consumers. Coke and Pepsi have for long appeared so strong in the fizzy drink business that all attempts to join them failed – there wasn’t an adequate reason to switch.   

 It particularly applies, it seems, in popular culture: is there any real reason to consider one music star better than the next? Hardly enough to justify the skewing of demand to the few stars. But, Lady Gaga it is, or The Beatles, or John Coltrane, Placido Domingo – a list of entertainment superstars that are good enough that most of us can stop looking. (And, as it happens, the same argument seems to apply to star CEOs in North American industry.)

At present, at least, this doesn’t apply to … clothes and cars and homes and home furnishings and eyeglasses (will Google Glass challenge this?) and watches and jewelry, each of which we see not as functional but as expressions of our personalities.

 But, Apple’s iPhones – for now – have the Star factor; most consumers simply don’t have a strong enough reason to look elsewhere. They had, in effect, so precisely defined the category that iPhones were not smartphones but The Smartphones, the super-cool-smarthphones everyone wanted.

2.  Learning curve benefits

It was long-ago established that a manufacturer’s costs of making a good (this was first studied properly in early production of airplanes in the 1930s!) went down with the CUMULATIVE volume produced. (Thus, this effect is separate from and in addition to the benefits of capital utilization, where some costs will decline with the volume produced in some time period.)

 The basic cost benefit of Learning Curve effects is expressed mathematically, here summarized as: for each doubling of the total quantity of items produced, costs decrease by the same proportion. Cumulative volumes of Apple iPhone unit sales by the end of 2012 exceeded 220 million – a staggering total - with just a few SKUs and models in the product’s brief history.[2] Assuming that Apple is able to reap the benefits of these learning curve effects[3], its cost basis should be 20% lower than that of its nearest competitor, Samsung, whose Galaxy phones have now also exceeded 130 million – but this volume is spread over far more SKUs and models. And the cost basis advantage should be enormous compared to the next-runs: Huawei, HTC, Motorola and Nokia.

3. Virtuous cycle in improvements

 Smartphones, more than almost anything ever invented, provide the device brand who originates it, with exceptional, “real-time”, flow of information on how they’re really being used – allowing the brand company to learn faster than anyone ever has before, how to adapt.

Built into each smartphone are a series of hooks that provide a continuous stream of data to their originators. (Apple and its app developers for the iPhones; each of Google / Android, the brand company and the app developers for Android phones). The data reveals where and how the phones are being used. To take a trivial example: a user might check the weather forecast each morning early. The phone brand and app maker will know where the user is … and whether they are satisfied with the first screen they see or need to open up another one to get the data they really want. If the data suggests that users are having to open up too many screens to get the right representation … the app or the smartphone software can adapt. And all of the data on these uses is flowing constantly to the phone developers and apps makers.

Thus, another advantage to Apple: it receives more data on more apps from more places. Best yet, these data on most markets’ early adopters of new technologies; for several years, Apple iPhone users drew more data, saw more sites, downloaded more content than others. In principal, this leaves Apple with vastly more knowledge on what consumers want – not what they say they want, but what they actually want- than any other market participant.

4.  A winning business model that leaves little margin for others

One thing that Apple did exceptionally well was to parse, accurately, the disaggregation of design and manufacture. According to the dominant strategy of the 1990s, computer firms no longer need to make anything: these tasks could be subordinated to contract manufacturers. This certainly took away a labor-intensive factory ethos that was a drag on the market impetus of some firms.

 However, by completely separating manufacture from the brand, a long-term trap was set, and most makers of Windows+Intel PCs slowly wandered into the trap. Their software was the same, the CPU was the same, the roadmap was set by others … and increasing amounts of the physical design were done by others, as their makers in Taiwan added value to their services, migrating upward from contract manufacturers to ODMs – original design manufacturers. ODMs became firms that could take on the consumer / industrial design, bring new materials and design ideas to the brand firms, better understand thermal issues and power issues than the brand firms. Eventually, much of the ability to do “real” design left the brand companies, leaving them hawking products made, and largely designed, by others. 

 Not so Apple. Apple kept a firm hand on the design. Yes, it long ago shuttered its last factory. Yes, its manufacturing is performed by many of the same firms that produce computers and phones for others. (Quanta, maker of MacBooks, makes PCs for Hewlett-Packard and others; Foxconn, maker of iPads and most iPhones … also made the original Amazon Kindle, makes hundreds of millions of other phones, and so on.) But Apple never let the design of the physical objects leave Cupertino, just as it never let control of its operating system slip away. Further, Apple generated its own content libraries, its own applications, and its own retail channels
In this sense, Apple is a far more vertically integrated company than most of its competitors (the key exception is Samsung). No factories, but far more of its product under its own control.
 This became an essential advantage for Apple, enabling it – quite uniquely – to deliver devices that were at the state of the art in most aspects, and devices that were exceptionally well integrated.

It also meant, however, that Apple makes more money in more places throughout the value chain. It meant that Apple’s customers were now connected to Apple for content, and for applications, and for products (and for the cool, super-cool image at the retail stores).
No competitor comes close to this: Android is disconnected from its handset users; the apps, for the most part, come from others, content from others still.
The unique benefits, then, for Apple are that it controls more of the business, makes more money in more places – and leaves its competitors with little financial headroom. Making competitive products and selling them at a loss is not a good business model.

At least for the time being, you will buy iPhones, and thus innovation in devices becomes narrowed: Apple gets to set the path forward, and competitors live and try to thrive in a market space defined and confined by Apple’s decisions. The iPhone has defined the sector so that consumers stop looking (Rosen’s research); competitors cannot easily beat Apple on costs (experience curve consequences), and the mass of apps and mining their data should provide Apple with the virtuous cycle of understanding what consumers need. Innovation seems, for a time, to freeze.

[1] http://gigaom.com/2013/04/02/a-new-iphone-may-be-on-track-to-arrive-this-summer/

[2] http://bgr.com/2013/01/17/iphone-sales-comparisons-samsung-294236/

[3] Not entirely clear, since iPhones are made by Foxconn (HonHai) and Pegatron (which makes the CDMA models)