Tuesday, 07 June 2011 05:37

Apple's Long Awaited Cloud Services and What They Mean In It's Battle With Google's Android

I have told subscribers that I would have to revisit the Apple valuation numbers after finding out more about their cloud services offerings. After all, embracing the cloud could potentially enable Apple to win the Mobile Computing Wars. As I have stated in my many rants regarding the Mobile Computing Wars, Apple is (strategically) placed behind Google. Apple's phenomenal growth appears to be blinding those with tree bark, disabling their ability to see forests. Google is a pure play internet company - plain and simple. Apple is a lifestyle computing. It's basically as simple as that breakdown. If the mobile computing wars ends up in the cloud, Google will probably dominate. If it ends up as a lifestyle phenomena dominated by brand and marketing, Apple has the edge. Apple is playing catch-up in cloud services and iOS 5 (just announced today, to launch in the fall) is its latest salvo.

One thing for sure, Apple's salvo into cloud computing has caused them to replicate much of Google's pricing. In other words they are now giving away substantial functionality for free, at the same time they will probably be forced to drop prices in their most strategic and profitable products. Google's business model was designed around the freemium concept. Apple's business model is that of the fat margin, walled garden. This portends what I have been warning about, ad nauseum, for some time. Apple will face margin compression.

Here's out take on their new offerings:

On Apple's unveiling of iOS5, Bloomberg gets it: Apple’s Jobs Set to Unveil ICloud to Deflect Google Android

Apple is using iCloud to retain its dominance in the smartphone and tablet markets amid fresh competition from devices powered by Google Inc. (GOOG)’s Android software.

Apple's dominance is in the tablet arena. It is not dominant in the smartphone arena, although it is a leading contender and the most profitable hardware vendor.

The new service may improve how users can access content across different Apple devices, keeping customers from defecting to rivals, said Frank Gillett, with Forrester Research Inc.

“The world we’re headed to is where you don’t have to think about which gadget has your stuff,” Gillett said. “As people get their content organized around one of these personal ecosystems, then it will be incredibly sticky because migrating won’t be convenient.”

If one were to cut through all of the marketing hoopla, and PR, one would discover that this is basically Apple's attempt to bring iOS on par with Google's ridiculously rapidly developing Android platform. This is a very difficult task for Android is growing AND EVOLVING at a truly unprecedented rate. I have anticipated most of these moves last year, as illustrated by the Mobile War posts of June and July, 2010, which have proven be quite prescient:

Android Now Outselling iOS? Explaining the Game of Chess That Google Plays in the Smart Phone Space

You will probably see Nokia adopt Android or Windows Mobile on some of its devices, or you will see continued market share decline. Nokia makes some kick-ass hardware, and will challenge HTC if they had the OS to go along with it.

Almost a year later, guess what happened to Nokia...

You can bet your left ass cheek that the iPhone 5 will have an Evo-sized screen with resolution to match today’s LCD flat screens, accompanied by the opening up of the iPhone to standards-based peripherals, ex. HDMI plugs and USB. The screen size increase is a definite, but peripherals is a maybe. Die hard Apple fans won’t mind that they have to jump through hoops to connect their device, but the rest of the world will lean towards an Android device if they can’t easily use their phone/tablet with existing hardware. Apple sees this as well as I do. I’m sure they’ll find a way to gimp the standard somewhat, but more open is better than less open.

And now we have Apple moving to the cloud to counter Google's Android's innate ability to move content and data between devices wirelessly.

 

  • Microsoft is guaranteed to extend their hegemony on the desktop and enterprise server space to the handset, as well as their reach into the consumer living room via the Xbox. The result? More functionality, more usability, and better overall products.

 

And almost as if on cue, the move of the entire Windows platform to the ultra mobile device in the form of Windows 8 has begun.

  • The Android clan (which is nearly everybody who is not RIM, Apple and MSFT, and maybe Nokia) will try their best to pump their R&D departments to their limits, and you will be getting bleeding edge products pushed to your door step on a quarterly basis until a clear winner is selected – which will probably be sometime from now.

Was this statement accurate? Do you want to see innovation? Well, Android vendors have imbibed the innovation elixir with R&D departments cranking full tilt: Google’s Excellent Execution On The Android Platform Goads S.E. Asian Manufacturers Into Low Margin Innovation War!

Thus far, I have been nearly 100% accurate in my prognostications, and the latest iOS5 announcements have solidified them even more. Here are some key takeaways...

Android seems to appeal most to three types of consumers:

  1. Vendors and retailers who are able to get a slice of the revenue pie without putting much into OS R&D
  2. Low end consumers who simply want a smart phone
  3. Very high end consumers are very technologically inclined and thus are more adroit at discerning the tech value proposition and identifying the marginal utility vs profit margin tradeoff. These are the consumers who are less susceptible to corporate marketing and often the one's who lead the technological trends, even when they aren't aware of it. The caveat is that they are the minority (headcount-wise) of consumers.

Apple's iOS products appeal primarily to:

  1. The lower end consumer who values ease of use over capability
  2. The lifestyle consumer who also tends to be the trend seeker and is quite status conscious. This consumer is much more susceptible to marketing than bullet number 3 above.
  3. Those who are generally more influenced by marketing.

With these platform buyer characteristics in mind, let's review the new Apple tech annonucement.

The most significant aspect of the iOS5 and desktop OS announcement was the purported arrival if iCloud, the Apple server farm service. This is a very expensive undertaking, yet a very necessary one for Apple needs to move iOS from its dated roots as a desktop tethered OS to a truly mobile OS - something that Android was designed to do from the start. This was/is not an inexpensive endeavor. From hardware, to systems design, to redundancy and network implementation, to software development and ongoing administration and maintenance... This ain't going to be cheap! As I have been warning, this will cut into Apple's margins, for while these offerings broaden the scope of services Apple can offer, Google has set the price/value bar so high that Apple could not possibly get away with the premium pricing that its shareholders have grown use to. What does this mean? Margin compression! I said it once (actually, twice, thrice and a multitude of times), and I'll say it again:

Apple doesn't just spend its money on hardware. Endgadget editorial puts it plainly:

Today, Steve Jobs revealed a great many things, but the biggest bombshell was this -- Apple's iCloud, which promises to sync all your content, automatically, even wirelessly, to Apple's new server farms... for free. All that processing power in the picture above can't have been cheap, and multiplied by the entirety of those data centers... well, let's just say it's a heck of a promise and we've got somewhat mixed feelings about how it'll play out. Hit the break to see what we thought of Apple's play for cloud storage.

...

... So much of the service is functionality already available on other platforms, particularly on Android -- if you consider Google Docs and Picasa a part of Android, at least.

Exactly! Apple is playing catch up here, and it is game that they are probably slated to lose due to a lack of resources in comparison to Google's 10,000 some programmers on staff, 500,000 open source programmers and testers (think XDA developers) and the R&D departments of Googles 1,000 some odd hardware and service vendors (PC vendors, smartphone vendors, carriers, 3rd party services and peripheral suppliers, etc.- all of whom are throwing back into the Android pool of intellectual property and and capabilities). Where we have Apple now is the taking of mostly all the new features of other OSs and making it seem like it is something new. This is far and wide an unmatched strength in Apple's management and implementation. Often, they consumerize  the product which aids in consumer adoption, ex.:

  1. iPod and iPod touch vs. Sony Walkman
  2. iPhone vs the smartphones pre-2008
  3. the iPad vs various Windows tablets

This has worked strongly in the favor of Apple for the last decade, but never (in that same ten year period, at least) have they been outclassed to the point where the competition has brought consumerization to the market first and Apple has had to play catch up. Android has done this and has done this in a very big way. Examples?

The notification bar system has been in use in Android since the original (Droid) circa 2009. It is one of the reasons Android became so popular (Android is now the number one OS in terms of growth and users both stateside and world wide). Apple's implementation looks to be almost a direct replica several years later.

Apple's iOS 5 Pull Down Notifications look to be a direct copy from Android, even down to the Weather widget
Android is leading the curve with mobile OS design spurring Apple to play catch up.

There's also active functionality from the lock screen, ex taking a picture without unlocking the phone (currently in Windows Phone 7 and Android Sense 3.0), integrated ebooks (Google "Galaxy S2", Honeycomb & Windows Phone 7), iMessenger (Blackberry Messenger and a superior implementation that integrates real time video conference in Google Talk, Android Gingerbread 2.3.4 and Honeycomb), Twitter Integration very similar to Facebook integration in WP7. It should be noted that the primary argument for justifying Apple's valuation is that they will be constantly innovating and coming up with new ideas that the competition will be playing catch up on. It truly appears that the reality of the situation is that Apple is the one playing catch up, and it is not running fast enough. Google just released two minor but very significant upgrades last quarter Gingerbread 2.3.4 and Honeycomb 3.1 (with no compromise playing of streaming Flash content in 720p) and is slated to release a major update in September with Ice Cream Sandwich which will meld phone and tablet OS into a unified, dynamic interface. Again, leapfrogging Apple's iOS which is just reaching parity with last years rendition of Android. Again, the resources that Android brings to bear with its highly unique, innovative and destructively disruptive business model will be literally impossible for Applet to compete with using a closed system and a fleet employees as programmers, engineers and designers. This will become more and more apparent to the masses as time goes on, at which point Apple will have to rely much more heavily on lifestyle marketing and much less on ecosystem and platform advantage.

Even the 200 new features touted in the iOS updated appear to be inspired by the 500 new features that is coming in the Windows Phone Mango update. The competition is truly fierce.

What iOS 5 does have going for it is its music in the cloud implementation - more Endgadget editorial:

Sean Hollister:...And then there's iTunes in the Cloud, $25 annually and basically a free ticket to turn all your ripped music into legit iTunes files in high-quality and with no DRM. In other words: iCloud as a whole may not make too may Android users jealous, but Google Music is already looking a bit dated, and it's not even out of beta yet.

I agree with this statement. It will be very difficult to compete with the Apple setup, but then again, this didn't come cheap. Amazon and Google apparently had the tech set up first, but both washed out of negotiations with the record labels. Now we know why. Apple had to pay up to $250 million up front plus accept the minority of the revenue split while managing the enormous data center operations - all while competing with the streaming services and MSFTs Zune service in pricing.  What was that term again? Oh yeah, Margin Compression!

Sean Hollister: All told, today's announcements weren't so much eye-popping as they were expected, but as with the introduction of copy-and-paste into the iOS universe, these "expected" additions bring iOS up to par with Android in terms of notifications, contacts, etc.

Zachary Lutz:... Ultimately, users will demand their content being effortlessly accessible, and I expect massive local storage to become an arcane concept (that only serves to inflate handset prices). Apple is known for changing paradigms and driving industries forward, but I fear it's got some catching up to do in the cloud. Nonetheless, today was quite a leap.

Dana Wollman:... For me, the biggest news here boils down to one word: "free."

As Apple Does Free, Expect Margins to Compress. Google Does Free Through the Largest Ad Subsidation Network In The World. Apple Will Have To Pull From Device/App Store/iTunes Revenue.

This is a very important concept. Google has offered practically all of these services for free for some time. People have gotten used to having a very high level of functionality for free, or at least for no out of pocket expense. Google's business model of search and advertising lends itself to the freemium model, and Android's open source, less than free business model even more so. Apple's fat margined closed ecosystem certainly does not. This is a true expense for Apple, one that will only grow with time. Outside of regular adminstration, storage, maintenance, redundancy, uptime and bandwidth issues, Apple will have to deal with its new found reality of hackers, malware, viruses and security - issues that are amplified and multiplied in the cloud. Higher expenses mixed with lower prices on the anticipation of higher volume means??? Let's here it again. Oh yeah, Margin Compression! Make no mistake about it, Apple will have to offer all of this dirt cheap to free to even think about slowing the Android slide.

And remember, this stuff hasn't launched yet. It will be launching somewhere around the launch of the iPhone 4 refresh, and the most major Android update in over a year - Ice Cream Sandwich. As Apple catches up to Android in September, expect Android to once again lap Apple's iOS upon launch!

With almost no exceptions, I'm not surprised to learn what iCloud actually does. And why be shocked? Certain features, such as email and calendar, have their roots in MobileMe, while a series of leaks and rumors primed us for the fact that syncing among devices was on the way. So it's not the functionality that impresses me so much as the fact that it won't cost anything. That, and the level of integration. I'm a long-time Android user, and I'll be the first to admit that many of the updates today borrow liberally from other platforms (hello, drop-down notifications!). But you know what? As an Android user I wish I could have more native integration between my handset and, say, my Google Docs. And I'd love to download the same things without having to pay all over again.

 

Apple doesn't get a whole lot of points for originality, but it deserves credit for making its service free, accessible, and tightly integrated. And if all of this rolls out smoothly, it would tell us that Apple's learned a whole lot about cloud services since its bungled MobileMe launch. Yes, you can say Apple is trying to out-Google Google at its own game (to quote our friend Sean Hollister), but if the result is a seamless service that offers functionality you're not used to getting for free, and puts pressure on its competitors to step it up, then it's we, the consumers, who ultimately win.

Sharif Sakr:  ... All my work and productivity is already in the cloud thanks to Google Docs, Dropbox and Windows Live Mesh (which has rescued me more times than I care to remember). My contacts and calendars already sync automatically from my iPhone to my Gmail account, and I even occasionally use the cloud photo storage function in Picasa. Like iCloud, they're all free. I don't see myself leaving any of these platforms to shift to Apple's all-in-one service because I'm still cross-platform and I do maybe 60% of my work on a PC.

Commenters: As an outsider of the Appleverse there was nothing here to make me want to join.  Seemed more like a patchwork update to cover some of the features available on other platforms and of course to make sure that it's completely locked in to the Appleverse.

I agree here as well. The Apple offering isn't compelling enough to bring in new users en masse. It seems aimed more at preventing defection.

More Signs of Margin Compession

Well, you know I feel the competition in tablets have already caused falling margins across the board:

The iPad is very important to Apple for it is its 2nd most valuable niche and helps diversify away the profit concentrations in the iPhone, which is responsible for over 70% of Apple's profit. This is dangerous, particularly considering the two of the very few eligible suppliers and Apple's main suppliers of the most strategic parts of both these devices also happen to be Apples first and second largest competitors in the phone and tablet space - both pushing Android. The margins on this product that pushes 70+% of Apples profit are high, 62% high, but that is coming to an end as well due to competitive forces wielded by Android.

Walmart cuts iPhone 4 price to $147

... In this case, Walmart has slashed the price of the 16GB iPhone 4 to $147—down from its regular $199 price tag—from now through June 30. Both the AT&T and Verizon editions of the phone are on sale.

But what does it mean? Apple has hinted that Monday’s WWDC keynote will not include major new hardware announcements, meaning Walmart likely isn’t making the price cut in advance of a brand new iPhone. (Or at least not one that’s expected to be announced this week.) A little more than a year ago, Walmart dropped the price of the 16GB iPhone 3GS from $197 to $97. That price cut occurred a couple weeks before WWDC 2010; Monday’s price cut was announced only a few hours before the event. Of course, the 3GS price cut last year was followed by Apple unveiling the iPhone 4. Walmart began selling the iPhone 4 in June 2010.

Walmart’s current iPhone 4 promotion includes both the black and white versions of the phone, and the discounted price is available through June 30.

What does this mean? Well, outside of being wonderful for consumers (as I anticipated last year), Apple's most profitable franchise will have to drop margins to maintain growth. As it is, market share growth has stagnated to a near stand still, assisted by share losses in RIM, which is basically dead in the water - exactly as I warned subscribers last year.

  1. The BoomBustBlog Multivariate Research in Motion Valuation Model: Ready for Download

As a matter of fact, we may update the RIM report, for the short may still have a ways to go. As for Apple, subscribers should reference File Icon Apple - Competition, Forensic Valuation and Cost Structure, page 4 to see our optimistic trends for iPhone margin compression.

Last modified on Monday, 11 July 2011 07:49

6 comments

  • Comment Link Reggie Middleton Wednesday, 08 June 2011 06:05 posted by Reggie Middleton

    It all adds up. apple is getting into relatively new territory where it's only experience has been failure. It will cost money to push this as a free service. Add in higher hardware and component costs, lower ASPs and more R&D and you will see evident margin compression in the medium term.

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  • Comment Link Reggie Middleton Wednesday, 08 June 2011 06:02 posted by Reggie Middleton

    I do. They are in the subscription downloads for Apple.

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  • Comment Link Eric Tuesday, 07 June 2011 18:53 posted by Eric

    I agree with you about probable margin contraction, I just don't see how they could spend enough money on iCloud to cause the margin contraction - I think it will be from lower sales prices, not from higher costs due to iCloud.

    Personally, I have no idea why people would want iCloud - but then again, I have no idea why people like Twitter either.

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  • Comment Link Kent Tuesday, 07 June 2011 17:09 posted by Kent

    Reggie, do you have any sort of ballpark EPS estimates for AAPL for the next 2 years or so? I'm trying to evaluate it as an investment and I'd love to hear what sorts of EPS growth you think they'll put up this year and next. You know as well as I do that the professional analysts estimates are worthless.

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  • Comment Link Reggie Middleton Tuesday, 07 June 2011 11:15 posted by Reggie Middleton

    A) it's a rumor
    B) more importantly, the cost is not upfront but ongoing. That billion dollars is going to support a lot of free functionality that won't directly bring in revenue but will directly bring in expenses. Notice that iOS 5 was jailbroken already, the desktop OS is getting compromised repetively, etc. It is quite likely Apple can have a Sony moment with their data (Credit cards, etc.) and spend massive resources to rectify it while attempting to guarantee uptime for free email, and syncing.

    It is something that Apple has to do to remain competitive with Google, but it is also a major departure from what the investors are use to and that is Apple charging premium prices for products and services upfront. There is no way margins won't take a hit. Apple is hoping volume increases will make up the difference, and it may, but it won't in the medium to long term if Google soaks up the volume. As it stands as of today, Google is winning the volume race.

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  • Comment Link Eric Tuesday, 07 June 2011 10:59 posted by Eric

    Rumors are that the Apple datacenter in NC cost about a billion dollars - say $25 million/quarter capitalized. Exactly how is that a huge deal for a company with 6.2 billion/quarter in free cash flow?

    That is less than their quarter to quarter growth in cash flow.

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