Apple Has Already Won The Tablet Market

| About: Apple Inc. (AAPL)

I once heard an eminent British historian proclaim that history did not in fact repeat itself; the problem was that historians tended to go around repeating one another. So when I hear that the present size of Apple (NASDAQ:AAPL) proves its growth is over, or that the days of Apple's tablet dominance are numbered because Google (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) both offer competing operating systems for tablet devices (Microsoft will purportedly offer it by year-end in the form of Windows 8) you can understand my skepticism. Sure, other large companies have lost room to grow in their markets - but what does that prove about Apple?

Google and Microsoft both have hugely successful software products. Google's ad-supported search service and Microsoft's licensing-based applications and operating systems businesses have enormous share of their respective markets. But what does this prove about their prospects in the tablet market?

Revisiting the iPod
Cast your mind back to the iPod. At first launch, there was one (1) model, and it had a 5GB capacity. It was Mac-only. It used Apple's Mac-only music software for synching, and its only interface was a firewire cable, limiting the potential for third-party support on non-Mac hardware. And - to cap it all off - it was, at $399, the most expensive MP3 player ever sold.

The criticism was immediate: $399 was expensive. Competing players, such as from Creative (OTCPK:CREAF), offered more than 5GB. The Firewire cable was non-standard in a world that had gone to USB. It was obviously a niche product, and was destined to go nowhere. And since it wasn't compatible with the Microsoft DRM built into every digital music store on the planet, it was doomed to obsolescence. You may forget now, but the fact that Microsoft announced the Windows Media Player as the new standard for music really meant something a decade ago.

But the devil was in the details. Apple's new iPod was a mere 6.5 oz, lighter than Creative's offering, and less bulky - a critical issue when considering a music player for running or other exercise. It used a 1.8" hard disc available only from Toshiba - if the word "available" could fairly be used after Apple absorbed virtually all the worldwide production of the drives. Toshiba's drive had a retail cost of $399, making the player effectively a free add-on to a drive bought at retail price. Some sites began popping up explaining how to obtain the unavailable drive by stripping out of the player with the same retail price tag.

After flirting with third-party applications for the support of iPods on non-Macs, Apple began making its music-encoding and music-library-management application available for Microsoft's platform and selling USB-based iPods. Then Apple added to its music-management application an interface to an online Apple store for music.

Once Apple allowed non-Macs to manage iPod contents, and had a store to protect users from the risk their device would be made obsolete by non-iPod-compatible music stores, the barrier to adoption dropped away. Apple's product was small, it did hold a ton of music, and managing its contents was pretty easy with Apple's iTunes application, regardless of whether one encoded music oneself or bought it from Apple's store.

Of course, when Apple's iPod began making the company tons of profits - and selling more iPods than all other manufacturers of MP3 players combined - people lined up to explain how competitors would eat its lunch. The thing was so expensive! But Apple slowly covered all the price points from $50 to $250, so there wasn't a competition-free zone in which a competitor could gain a foothold to mount a counterstrike on Apple's commanding share. From the minimal-sized but 2GB iPod shuffle through the color-screened iPod Nano, to the iOS-based iPod Touch, Apple sells music players at a profit at virtually every price point from $50 to $350.

After more than a decade, Apple's share of the portable music market still stands at a commanding 78% - despite Apple deliberately foregoing the DRM-based music-store lock-in so long sought by the likes of Microsoft. They did so by first destroying the market for non-iPod-compatible music, (RIP Sony's ATRAC store, WMA-based stores, and Plays-for-Sure anywhere) then convincing the music labels to allow it to sell music DRM-free. Apple isn't competing by locking customers into crippled music, it's competing by destroying the market for crippled music and then selling the best consumer experience in the portable music world.

And where might that experience lead? Neil Young gave an interview with All Things D in which he lambasted the poor quality of MP3 music (the encoding used by Amazon's store) and explained that when Steve Jobs went home he listened to vinyl. Seemingly in answer to Neil's plea for high-quality music, Apple has announced new mastering standards for submitting music to Apple's online store at above-CD-quality so that it can be supplied to different devices over different types of connections at different quality levels, including better-than-CD-quality for the high-fidelity crowd that's been waiting for for several decades for something better than a CD. That's especially good news for people using AppleTV or Airport Express to hear on home entertainment systems music streamed from a home computer using their on-hand iPhone or iPod Touch as a remote control.

As described in an earlier article, Apple is the world's largest buyer of flash memory on which portable music players depend, and has bought flash memory control technology that will ultimately allow Apple to use less costly hardware to deliver better performing memory. Apple's proprietary technology and economies of scale combine with its quality and reputation to prevent a serious attack on its dominant position in the music player market.

And this, despite a decade of competition. Not from little start-ups or companies that a decade ago were the size of Apple a decade ago, but from longstanding music hardware manufacturers like Sony (NYSE:SNE), and world-renowned online vendors like Amazon (NASDAQ:AMZN), and from seasoned software giants like Microsoft and Google. (Ever tried Google Play? Me neither. Even if you did, it wouldn't keep you from playing music on Apple's music players.)

The upshot? Apple is just as happy if you encode CDs using Apple's lossless compression tool as if you buy your music from Amazon, except that angels cry when good music is downgraded through MP3 compression. Regardless of what you want to hear, Apple will continue to offer mobile and home audio solutions that increasingly enjoy support from iCloud rather than requiring a home computer for local content support. This ease of use will continue, keeping Apple in good stead while it maintains price and margins superiority through its scale and its identification of technology that improves the underlying devices.

And while Apple has expanded from music into movies, and enabled iCloud support of movie libraries to support its growing multimedia business, it hasn't lost its grip on music. Apple's music-player business is safe.

Apple's Second Portable Device
After Apple wowed the world by taking on and defeating the likes of Microsoft and Sony to revolutionize not just digital music but worldwide music sales, Apple didn't quit. Apple's next device was, in effect, an iPod Touch that could make phone calls.

Oh, the complaints were awful. It was the most expensive phone ever. It had no keyboard. It wasn't ready for enterprise. Nobody but Apple could make applications for it, unless they were web applications.

The thing was off like a rocket. As with the iPod, Apple slowly added things that made it more attractive. An iOS App Store from which cryptographically-signed third-party applications could be bought and loaded directly onto the device - and which Apple could disable in the event of a security breach. GPS for more precise location than was reliable with cell-tower positioning. Improved accelerometers for better experience with the games that were becoming so popular on iOS devices. Higher screen resolution. And since Apple's new phone was not only the highest-use cell phone camera on Flickr but the highest use camera of any type on Flickr, Apple developed an improved optic system to get more light focused better on a larger CCD to make even better pictures possible with Apple's improved photo software.

Click to enlarge:

Apple's iPhone wasn't even intended as a camera, but since it's on-hand, it is pressed into service for the purpose. Apple recognizes the fact by making it better at this obviously-frequent purpose.

Along the way, Apple built in a variety of enterprise-friendly management features and launched an iPhone configuration tool for mass-configuring phones by businesses. In the enterprise - longtime bailiwick of Research in Motion (RIMM) - Apple is taking account after account with no end in sight.

Apple's success isn't based solely on first-mover status. Competitors have had several years to respond with devices of their own. Apple's success isn't based on multi-touch patents, as competing multi-touch-capable hardware products abound. The iPod Touch and iPhone businesses are part of an iOS ecosystem that delivers ease of use to users, an outstanding development environment for programmers, and a competitive price. The fact that this recipe is well-understood doesn't mean anyone's in a position to replicate it.

What, Apple? Competitive price? Apple's "most expensive phone in the world" now ships at a variety of price points from $0 to as much as one may care to spend on a phone.
Apple's practice of maintaining an older mobile device at a discounted price when upgrading the company's flagship product enables Apple to replicate with mobile devices what it achieved with the iPod: Numerous price points for profitable products that choke the air off competitors' ability to find an uncontested foothold at some price "too cheap for Apple" to compete.

About Apple's Mobile Platform
Apple's mobile devices run a version of Apple's Unix operating system derived from intellectual property acquired in its acquisition of NeXT. Apple's development environment, called Cocoa, is based on a NeXT-designed object-oriented language and includes years of refinements designed to facilitate easy access to hardware-accelerated graphics, vector-based math, graphical interface animation offloading into separate threads; numerous little miracles developers get "for free" when using Apple's Cocoa programming interfaces.

Apple's support of standards for offloading computation to graphics subsystems makes special sense as one considers the increasingly beefy graphics support in Apple's newer products: It makes all the applications that run on Apple's platforms perform better, even if the developers have no idea what hardware Apple is building into its products. (For the nerds: Cocoa's Objective-C supports runtime linking, so that Apple updates to support novel hardware can be linked into even very old programs that leverage Apple programming interfaces for math, graphics, or even Unicode string comparisons. Instead of a new operating system obsoleting one's software, Apple's new operating system updates give users' applications all a free performance update. Dig it!) Apple's inclusion in Cocoa of open standards like OpenGL and OpenCL mean that Apple induces hardware vendors to support hardware acceleration of those standards' instructions, while at the same time inviting developers to use Apple interfaces to those standards so that they don't need to write hardware-specific code to access them. In other words, developers on Apple platforms don't need intimate knowledge of every GPU-maker's hardware, just familiarity with Apple's graphics APIs.

Apple worries about hardware-accelerating its programming interfaces. The availability and reliability of a platform's programming interfaces aren't unconnected to users' experience with applications. They can actually dictate which applications a developer is willing to maintain on a platform. (For those who won't click, the link describes why a game developer is dumping Android to stick with iOS. The platform's workload is higher because of its unexpectedly misbehaving graphics drivers, causing Android to require 20% of the company's personnel resources despite providing only 5% of the developer's revenue. The developer tried Amazon's store instead of Google's, but it didn't help revenue. Android development wasn't worth the trouble.)

Developer support is not limited to operational code. Apple supports developers in shipping one single application worldwide, with user preferences enabling access to any language a developer chooses to support in the application. There's a reason Apple sells so well internationally. Its beautiful Unicode characters and multi-language support make international users first-class participants in the Apple experience.

What does this mean? Developers get more bang for their work on iOS. Developers dump competing platforms for iOS once they've experienced the difference (e.g. Skobbler, Kayak, Mika Mobile, watch the news). The value added by Android is so slight that when Mozilla built a system based on its own browser, it didn't bother to include Android, even though Android is open source and licensed for free.

Apple's Tablet Market
Apple's tablet entered a market segment that was so small Apple was criticized for targeting a market in which there was no money to be made. Tablets were not just less than a million units a year, they were less than ten thousand a month. Soon, Apple was selling more per month than all other manufacturers could manage in a year. Now, some will say Amazon is eating into Apple's tablet market, but let's have a real look at the difference between Amazon's target customer and Apple's.

Apple wants a customer willing to plunk down hundreds of dollars on a piece of hardware that will profit Apple even if they never choose to plunk down more money on other Apple products and services, or on third-party applications vended by Apple through its App store. Apple makes good money on these machines. Apple does not make loss leaders. Amazon deliberately loses money on each Kindle Fire it sells for $200, in the hope that customers' subsequent purchases through Amazon's store (including its Kindle Store electronic bookselling portal) will earn back Amazon's lost money and more. Despite that the Kindle Fire is an Android device, Amazon's tablet doesn't run applications from the Google-curated Android Market. Amazon's device runs Kindle Fire applications.

Kindle Fires are by all accounts outstanding at performing the services expected of Kindle Fires, but it is a mistake to consider them ready substitutes for members of some larger Android-tablet market, or iPads. The devices are built differently, have different software, and target different uses. To most actual users, neither device is a replacement for the other. Don't believe it? Just before the recent iPad launch, over half of Kindle Fire owners planned to buy the new iPad.

To think about the larger tablet market, it is necessary to look at the software and hardware that comprise the products commonly thought of as members of that market segment.

Tablet Software Considerations
And as discussed above, developers have to do different things to access the Kindle Fire application market than to access the Google-curated Android Market. Since the devices at each store and their supporting graphics hardware and associated drivers are all different, it's clear that testing the usability of a developer's applications across the plausible spectrum of customer hardware is beyond the reach of one-man and two-man software development firms. People wanting to concentrate their development effort for maximum payoff have a clear choice: Apple's App Store.

Not only does Apple have a well-developed API with a heritage dating back to Unix workstations of an earlier century, but customers actually update the software. This may sound silly to you as a reader: How much does your phone really change for you with each software update? But to developers it's show-stoppingly important. If you want to sell a piece of software that depends on the application interfaces supplied by another vendor, it's essential to know what those interfaces are and what bugs you need to work around. At, a chart depicts just how many major OS versions developers must test against in the iPhone and Android universes. Android users' smartphone operating system updates are dependent on the manufacturers or call carriers. John Gruber points out that the poor software update environment for Android users has a direct effect on the platform as a whole. As a demonstration of the effect of this in the real world, consider a new piece of software, just released this year: Google's browser Chrome has come to Android! The problem? It runs only on an operating system available on about 1% of Android devices. For an updated chart of OS versions currently running on real users' Android devices, look no further than Google's own developer site. But as of this writing, the story is pretty bad for Android developers:

The vast and overwhelming majority of Android devices are running some version of Android 2.3 ("Gingerbread") or 2.2 ("Froyo"). The current version is 4.x ("Ice Cream Sandwich"). Even the last major version (3.x, "Honeycomb") is adopted by less than 5% of real Android users in the wild.

Android developers either target an operating system with no users, or they target an operating system made obsolete by the subsequent release of two major OS versions. Therefore it does not support any of the advances made to improve the lives of developers that would be reflected in the last two major releases. Can you imagine an iOS developer today being asked to target iOS version 3.x? Less than a month after the release of iOS v.5, 38% of iPhones had adopted it. Apple's iOS 5 was adopted at record rates, eclipsing iOS 3 in less than a week. Last week, iOS 5 had hit 75% adoption. The result is this:

"iOS 5.0 works on all the iPads, there's not much of a reason to support older iOS versions," sayd Haddad. "There's a few people who are still running iOS 4.3 on iPad but that number is minuscule compared to the folks who have upgraded. It makes very little sense to spend the development effort support 4.x on iPads."
"Developers Love iOS for A Lot of Reasons", Matthew Panzarino,

Simple, right? iPad users who are interested in buying applications are willing to install a new free operating system, so there's no developer enslavement to obsolete technology and less need to worry about support for numerous old OS versions. So no, one can't imagine asking an iOS developer to target iOS 3 with a new application. The last link really spells this out. With Apple's platform, developers have the power to develop for the OS that offers the application support preferred by the developer. With other platforms, developers have to suffer platforms made available by carriers that have little stake in whether developers succeed or fail.

Apple's Tablet Hardware
Epic Games may have inadvertently showcased a major strength of Apple's tablet ecosystem: Apple's tablet. While demonstrating a next-generation game engine on prototype hardware provided by NVIDIA (NASDAQ:NVDA), Epic VP Mark Rein warned that if the next generation of consoles didn't significantly raise the bar on hardware performance, they would be overtaken by the iPad. Such claims aren't empty. In 2006, Epic's demonstration of what its game would look like on a 256MB console with no hard drive was responsible for Microsoft's decision to add a billion dollars in costs to its then-developing XBox product. And Epic is free to jump ship with the next Gears of War, or any other title it chooses to advance as the showcase for modern games.

Think about this: Apple has just quadrupled the number of pixels on its tablet, added to its dual-core CPU a new quad-core graphics engine, and dramatically improved cellular data speeds while maintaining 9-hour battery life (10 hours without 4G data). Apple offers this product not only in volume but at a profit. And that's a non-subsidized profit. iPads don't come with required wireless contracts. The only way to keep gamers from jumping ship to Apple's platform - according to Epic Games - is hardware so over-the-top that it must be subsidized by software licensing or other revenue (advertisements, subscriptions, etc.). Worse for Apple's competitors is that exclusive titles that draw fans to particular devices cost console makers a pretty penny (that exclusivity doesn't come free), eating into the payback period for a competing product.

And don't think tablets are really a different market than game machines. Electronic Arts (NASDAQ:EA) specifically targets iOS with pre-holiday marketing designed to take advantage of Christmas-morning iTunes gift cards. AppleTV cheerfully displays on your big screen in 1080p the HD video from recent iOS devices, so console junkies requiring the big screen can get it. And people wanting to view their HD movies shot on the iOS devices can view them in large size. Nice.

Since iOS developers aren't forced to spend a fortune in licensing costs from a console maker desperate to earn back losses on a subsidized hardware product, developers keep more of sales and have less at risk, thus earn a faster payback on their development investment. The fact that developers don't need to compete with each other for limited physical shelf space to get titles into local vendors' finite physical inventory means they can compete on factors other than their relationships with publishers and distributors. Mobile developers can thus control overhead previously lost to additional layers of middlemen; in the iOS market, a developer must pay advertising costs (if any) and the retailer, since the retailer picks up storage, transmission, credit transaction costs, and so forth. The economics therefore favor mobile development, inviting more titles and more choice than on costly consoles that can be used only while at home. With game prices much lower than on traditional console platforms, players can load up with titles or find new adventure without much incremental cost.

Already, iOS trounces Nintendo (OTCPK:NTDOY) and Sony game handhelds in the booming mobile gaming market. Are consoles next? Cloud gaming firm OnLive wants iOS customers and promises console quality on the devices. The immortal John Carmack (heard of Id?) has gone on record that it is 'unquestionable' that mobile devices will surpass sales of current consoles. The question for console makers is whether they are willing to up the ante on performance to reach some level that distinguishes their offerings from iPads. The next question is how long it is possible to offer performance that will be noticeably better than an iPad.

To Apple, the console competition does not matter. After all, that iPad was for business presentations, right? Or the kids' educational applications? Books light enough to carry while you travel? Whatever the first reason to buy, you have it anyway, so making it into your game console is pretty cheap from here. Apple's only interest is that you love using the hardware enough to stay with the brand.

Apple buttresses the brand with product design and engineering effort that is unbeaten in the consumer space. Users of the products love them. Apple supports those who do face problems with top-ranked support.

And the iPad, like the iPod, is coming down in price. The new iPad didn't displace the prior model, it simply justified a price drop in the old model as the new model picked up the prior prices. Eventually, Apple will cover all the price points at which competition is plausible and own the niche just as obviously as it owns music players.

To close this article, and illuminate that Apple is nowhere near resting on its laurels so as to be caught by competitors, I offer a quote from Apple's launch of the new iPad:

It's what we love to do. It's what we stand for. And across the year, you're going to see a lot more of this kind of innovation. We are just getting started.
Tim Cook, via Daring Fireball

The very economies of scale and internally-developed IP that make Apple indomitable in music and phones are at work in the tablet space. Last year, I summed the conclusion up in my article iPad:Tablet::iPod:MP3 Player. Or, as John Gruber recently summarized, The iPad Is Unbeatable. The additional details here are merely further illustration of what competitors are slow to realize.

Apple has won the market.

Disclosure: I am long AAPL.

Additional Disclosure: The author has maintained a short position in RIMM since the publication of "Apple: The Long and the Short of It". The author's short position in RIMM may close within the next 72 hours due to potential option exercise at the next expiration date.

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