Apple Must Totally Change Its DNA To Survive And Thrive In A Brutal Competitive Environment

| About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) must strategically totally change its DNA as a hardware firm in order to survive and thrive in an increasingly brutal competitive environment and drive shareholder value. The recent collapse in Apple's share price has nothing to do with its cash hoard and everything to do with a strategy that refuses to de-bundle software from hardware as a necessity to maintain competitive dominance.

The recent notion among some investors that core strategic and competitive challenges posed by Google's (NASDAQ:GOOG) Android in mobile operating systems and by Samsung (OTC:SSNLF) in smartphones should somehow be solved by a financial response is absolute hubris and nonsense and totally ignores the real competitive issues at stake.

Upon the death of a founder CEO, companies need to strategically decide, like children, if they wish to inherit both the strengths and the weaknesses of their parents, or just the strengths. I would argue that Steve Jobs' notion that an absolutist aesthetic goal of a Zen-like melding of form and function (hardware and software), while somehow noble and grand in its vision, would be appropriate for a private company where the founder can choose aesthetic Zen-like perfection over profits. However, this strategic orientation is absolutely inappropriate for a public company, which should seek absolute profit within the bounds of ethical constraints.

And there is a rich vein of history for Apple executives to mine should they begin to question the wisdom of blindly following Steve Jobs' absolutist aesthetic vision. It goes back to NeXt Computer itself, and Steve Jobs' refusal to license its clearly superior NeXtStep operating system to IBM (NYSE:IBM) and other PC makers. Steve Jobs' strategically viewed Apple, and later NeXt, as a computer maker, rather than a software company. As outlined in the wonderful book, "The Second Coming of Steve Jobs", it was his very inability to see the software as the most valuable technology the company owned and to reinvent NeXt as a software firm that should license its operating system to PC manufacturers that sealed NeXt's fate, and perhaps more importantly, denied generations of PC owners less buggy operating system software. Jobs' refusal to view Apple and later NeXt as software firms that should create operating systems for other computer makers to license was responsible for Bill Gates as opposed to Steve Jobs becoming the richest person in the world.

If Apple does not radically change its strategy, there will be a repeat of Steve Jobs' strategic blunders in dealing with PC clones and Microsoft (NASDAQ:MSFT), but this time in the mobile world. For example, Apple had the first commercial graphic user interface (GUI) in the computer industry, but Microsoft capitalized on the GUI by making its own version (Windows) which it licensed to PC makers, creating an industry-standard operating system platform. Steve Jobs viewed this as a huge betrayal by Bill Gates. More recently, Google's Android is being used by smartphone makers such as Samsung, and the biography, "Steve Jobs" by Walter Isaacson, outlines how Jobs viewed much of Android's functionality as infringing upon Apple's technology. Does this sound familiar?

Apple is literally upon the precipice of losing its dominance in smartphones, not due to inferior technology, but due to dumb circa 1980's competitive strategy. Refusing to license their operating system did not work for Apple in the 80's, 90's or 2000's, and it will not work for Apple in 2013. It is a strategy which is perfectly designed for revolutionizing a new category, burning bright for 4-8 years, then peaking and being unable to maintain competitive dominance. The counter-strategy is being second, but strategically smarter. The counter-strategy is about not being so arrogant and stuffy and parochial about licensing to and partnering with hardware manufacturers to create an industry standard which maintains continued dominance for years to come.

But most importantly, recent developments have driven this situation to a head. There are physical limits to Apple's growth as a premium provider of superior computers, phones, and tablets. So far, Apple's competitive response has been to create or to recreate new categories, as it has with the iPad. Even if Apple can do this again with TV or some other category, its refusal to see itself as a software firm leaves it vulnerable and with limited competitive responses to Google's Android and to the Windows Phone operating system, and to Samsung's increasingly impressive hardware as represented by the Galaxy Note II.

Quite literally, Apple is being attacked on all fronts by software and hardware makers. In its early history, it believed that superior products would safeguard its future. This was and has always been Steve Jobs' driving belief, along with his uncompromising aesthetic vision. But just as Ford (NYSE:F) and GM (NYSE:GM) first experienced cheap Japanese economy car makers such as Toyota (NYSE:TM) and Honda (NYSE:HMC) first flood the low-end market and eventually work their way up to compete with their Lincoln and Cadillac brands with Lexus and Infiniti, Apple was brought to the brink of destruction by PC makers which teamed up with Microsoft.

The strategic lesson that Microsoft taught the entire tech industry is that owning the platform itself was the best place to be in the value chain for both profits and for a strategic monopoly. Google learned that lesson and has sought to use its search engine as a beachhead to create platforms of its own, such as Android and Chrome based operating systems.

In the movie, "Margin Call," the fictional investment banking CEO John Tuld reminds his employees that "There are three ways to make a living in this business: be first, be smarter, or cheat." Indeed, if Steve Jobs was correct that superior products would safeguard Apple's future, he would have dominated the computer industry during his first tenure as CEO. The answer as to why Apple's share price rose so dramatically during his second tenure as CEO is that Apple was really the first in the smartphone market, just as its first major stock rise after its founding was the result of Apple having the first commercially available GUI.

Now Apple's competitors have started to catch up, and we should stop making the strategic attribution error that superior products created the upward wave in Apple's stock price. It was being first in a brand new product category with an amazing product. But staying in strategic and competitive dominance of that category requires and new and different response perfected by Microsoft called Owning The Platform which is strategically far smarter.

And the good news for Apple is that Microsoft has recently had a massive blunder with its rollout of Windows 8, which is widely hated. There has never been a better time than now for Apple to attack both Microsoft and Google and to encroach on their traditional operating system turf, creating panic and disarray. Because such a move would run totally counter to Apple's DNA, it would be absolutely unexpected. And it would stop the terrible cycle of Google and Microsoft throwing competitive punches that are never counter-attacked, but merely parried by Apple. The time for Apple to encroach upon Microsoft and Google's turf is now or never.

Instead, Apple is internally focused on a totally strategically meaningless maps brouhaha -- Tim Cook even wrote a public letter apologizing -- and is forgetting that its Unix-based operating system for computers and its iOS operating system for phones are absolutely the best products on the market according to many critics. Apple needs to attack Microsoft and Google on the operating system front immediately.

Not only would it keep its identity as a manufacturer of premium hardware products, but it could also capture the majority of the operating system market for phones and perhaps computers, extracting almost a tax throughout the whole computer/phone ecosystem, as Microsoft has done for years with PCs. What could be a better outcome? Keep one's business as a premium hardware manufacturer, and extract a toll for the use of one's operating system from everyone else.

For instance, current competitors such as Samsung could also be turned into customers. And perhaps more importantly, a premium competitor such as Samsung which may not want to license Apple's iOS for its phones for strategic reasons could be mortally weakened by giving its more commoditized competitors access to iOS. And these competitors would jump at the chance to have a differentiated competitive response to Samsung. Rather than fighting Samsung directly, it could give fuel to Samsung's competitors and thereby weaken its rising dominance, just as countries seek to dampen each others' strategic dominance by creating regional counterweights. And not everyone will be able to buy an iPhone. Why not sell the operating system to other hardware firms? If Apple does not, another operating system provider will, and that revenue will strengthen the competitor. But wait a moment, that's what's happening now.

Extraordinary claims require extraordinary evidence. And it is an extraordinary claim that there is any shareholder value-centric position that Apple should continue to stay out of the business of licensing its operating systems, especially after Steve Jobs' death. What are the potential spoils for Apple entering an operating system war? Last quarter, Microsoft brought in $5.881 billion in operating revenue from its Windows Division according to its latest 10-Q. Of this $5.881 billion in operating revenue, 65% of this was from sales to original equipment manufacturers, or $3.832 billion. Assuming a 52% operating margin from OEM sales, that would be $2 billion in operating income a quarter from Windows sales to OEMs. How much of this market Apple could take from Microsoft is unclear, but the potential prize is enormous. And thus far, Apple has decided not to compete at all for a prize that it has a decent chance of winning given the weaknesses in Windows 8.

Perhaps even more importantly, Android now has 70% market share in the smartphone market, with Apple's iOS market share down to 21%. There is no strategic reason whatsoever why iOS should not be dominant rather than Android, if Apple made the strategic decision to license iOS to other hardware makers. Even more interesting, 25%-30% of all search traffic could be coming from mobile devices by 2014. If Apple does an about-face and uses its iOS to become the dominant operating system for smartphones, it could use that position as a beachhead to encroach on Google's dominance in search, rather than reacting to Google's use of search as a beachhead to creating Android and dominating the mobile market.

Literally, if Apple does nothing, it will allow its dominance in smartphones to be eclipsed by other competitors, who while not visionary and first, are strategically smarter. Consumers will be doomed to inferior software, as they were for years with Windows, and the spoils of the mobile market will go to those with better business strategies as opposed to technology. Apple has a golden opportunity to reject the weaknesses of its founder, and to build upon the many strengths of its inheritance--chief among those being better operating systems.

And most importantly, a radical change in Apple's DNA would make $1,000 a share look like a starting point. Apple should not just keep staying on the hamster wheel of reinventing product categories -- it must reinvent and continue to dominate those categories for its shareholders by owning, licensing, and dominating industry standard operating systems -- a platform which is so dominant, that all of its competitors must use it, thereby turning them into customers as well.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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