Rebutting Clayton Christensen on Apple's 'Troubled' Future (AAPL, MSFT, DELL)

|
Includes: AAPL, DELL, MSFT
by: Yankee Group

By Carl Howe

BusinessWeek has an article interviewing Clayton Christensen, author of The Innovator's Dilemma, entitled "How Apple Could Mess Up, Again". In it, he argues that Apple will fail again because PC history will repeat itself, with standards-based products unseating a dominant proprietary supplier. My opinion: Christensen has forgotten what actually happened in the PC business and is remembering Microsoft press releases as revisionist history. Let's look at Christensen's opening statement:

During the early stages of an industry, when the functionality and reliability of a product isn't yet adequate to meet customer's needs, a proprietary solution is almost always the right solution -- because it allows you to knit all the pieces together in an optimized way.

But once the technology matures and becomes good enough, industry standards emerge. That leads to the standardization of interfaces, which lets companies specialize on pieces of the overall system, and the product becomes modular. At that point, the competitive advantage of the early leader dissipates, and the ability to make money migrates to whoever controls the performance-defining subsystem.

In the modular PC world, that meant Microsoft and Intel (NASDAQ:INTC), and the same thing will happen in the iPod world as well. Apple may think the proprietary iPod is their competitive advantage, but it's temporary. In the future, what will matter will be the software inside that lets users find exactly the kind of music they want to listen to, when and where they want to, with minimal effort.

A couple of points are just flat wrong here. When IBM introduced its PC in 1981, it wasn't a standard, nor did anyone have any clue who Microsoft and Intel were. IBM built a near-monopoly in the PC business because of its validation by millions of existing IBM customers in businesses and IBM's excellent advertising and branding campaign. But it was actually IBM who tried to move the PC business to a proprietary one by introducing its PS/2 series, using its own OS/2 software (built by Microsoft but to IBM specs), Intel chips, and a proprietary PS/2 bus. Buyers who had existing software and peripherals that would no longer work rejected this proprietary standard, and went with Compaq computers that supported these tools. Without the branding and support of IBM, customers looked for a new set of features they could specify to allow them to buy Compaq (remember, no one ever got fired for buying IBM), and they settled on Intel processors, Microsoft software, and an EISA bus, and claimed they were standards. But the rebellion was against IBM's proprietary systems, not Apple's.

The incorrect assumption Christensen is making is that Microsoft is capable of convincing users to adopt its proprietary standards instead of Apple's. The fact that Microsoft offers it does not make it a de facto standard -- in fact, Microsoft currently accounts for less than 15% of the market for music and music players. And Microsoft's software is every bit as proprietary as Apple's; it just is from a company that licenses it, whereas Apple's isn't licensable -- yet.

But Christensen's viewpoint becomes clearer with one of his later comments:

[In response to a question "Given the delay of Microsoft's Vista software, widespread malware problems with Windows, and Apple's move to the Intel platform. Don't you think that will enable Apple to gain some significant share in PCs?"]

I don't. I think it will allow them to survive for a bit longer. I think most people are satisfied with their current PCs (using Windows and based on Intel chips) and find that the performance of their systems is good enough. Sure, there are people at the bleeding edge who want to do more. But a good Dell PC can be had for $500, and it has performance that's well beyond what most of us need.

The "survive a bit longer" comment shows he hasn't looked at Apple's financials lately. The company grew earnings more than 300% last year on more than 50% revenue growth. The company has $9 billion in cash. I'd bet more on Dell dying at this point than Apple.

But more worrisome is that Christensen, a Harvard Business School professor, believes that it doesn't matter if products work or are marketed well, so long as they are cheap and good enough. So using this reasoning, companies like Lexus, Mercedes, BMW, Acura, Cadillac, Hummer, and even Honda should fold up shop because they aren't as cheap as a Kia cars. Why do I suspect Christensen isn't driving a Kia?

The surprise to me is that Christensen ignores the profitability of the businesses in his argument. That Dell PC he lauds isn't making Dell much money if any; in fact, Dell is shifting its mix to much more expensive PCs because it can't make its profit goals on $399 PCs. So much for standards driving prices down. And companies like Alienware and Shuttle seem to be doing just fine with quite pricey PCs. Of the companies selling PCs today, no one makes higher margins on its products than Apple, yet its products are comparably priced. And when we get results of the Christmas selling season this month, I believe we will not see another PC company who sold more units at Christmas than the nine million or so iPods Apple sold at prices rivaling those dirt cheap PCs, yet the iPods boasted nearly 50% gross margins.

I accept The Innovator's Dilemma: that market leaders who have a huge investment in the status quo rarely can find the corporate will or can accept the business risk associated with jumping to the next big thing. But the music player market is only 10% penetrated in the US, and less so world-wide. There is plenty of opportunity for Apple to imitate the Sony Walkman and lead that market for years to come. And the real company with the innovator's dilemma in the PC market is Microsoft, who hasn't been able to figure out how to improve on its core OS product in nearly five years since Windows XP, and now that it is doing so, it is largely doing it by copying Apple's OS feature set. And its stock price currently reflects that fact, given that MSFT is down about 21% during that five year period.

Apple will make mistakes as it moves forward, because it is taking chances with new ideas, products, and markets. But If Christensen wants a great case study for a company that couldn't get past the Innovator's Dilemma, it seems to me that Redmond is more fertile ground today than Cupertino. He just has to look at the real numbers and history, not revisionist stories.