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Welcome To Planet Apple


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Steve Jobs had plenty of problems to contend with as he sauntered onstage for his first speech after returning to the top of Apple in 1997. He faced a shrinking market for his Mac computers, bloated costs, and a severe shortage of cash. But on that day, Jobs chose to talk to the Mac faithful mostly about another problem: Apple's growing isolation. Despite the company's reputation for making the world's finest PCs, very little software or add-on gear worked with the Mac. "Apple lives in an ecosystem, and it needs help from other partners," said Jobs. "And it needs to help other partners."

Jobs then did the unthinkable, inviting arch-nemesis Bill Gates to join him on stage via videoconference to announce details of a deal to forget any patent claims in exchange for $150 million, and a promise by Microsoft Corp. (MSFT) to continue making a Mac-compatible version of its ubiquitous Office software.

Today, that Apple Inc. (AAPL) ecosystem has morphed from a sad little high-tech shtetl into a global empire. Once known for defining the digital future but never fully capitalizing on it, Apple has been transformed into tech's most influential hit-maker. More than 200,000 companies have signed on in the past year to create Apple-compatible products, a 26% increase from the year before. That includes software makers such as gamemaker Electronic Arts Inc. and corporate supplier VMware, drawn by Mac sales that are growing three times faster than the overall PC market. A cottage industry of iPod accessories continues to blossom into something far more substantial. Consider that this year, some 70% of new U.S.-model cars have iPod connectors built in, and about 100,000 airline seats will have the same. And Apple's online iTunes Music Store has become the world's third-largest music retailer after Wal-Mart Stores Inc. (WMT) and Best Buy Co. (BBY)

JOINING THE JOBS CLUB

With the June 29 debut of the iPhone, Apple seems poised to extend its reach even further. A new flock of partners, from AT&T Corp. to Salesforce.com Inc. (CRM), is set to jump on the bandwagon for the slick phone/Web browser/music player/camera. Sure, the hype prior to iPhone's launch bordered on ridiculous's (Comedy Central (VIA) Stephen Colbert joked that the iPhone launch is the second most important event in human history, after the birth of Christ). But phonemakers such as Nokia (NOK) and Motorola (MOT), and carriers like Verizon (VZ), are waiting nervously to see if Apple can remake the U.S. cellular business by determining what services consumers get and leaving the carriers out of the loop.

As long as Apple stays on its game, leading providers of everything from silicon chips to Hollywood flicks will feel pressure to strike deals to Jobs' liking. Apple can confer brand hipness on its partners. And its ascendence in markets like cell phones and who knows what else in the future may impose a new focus on more consumer-friendly parts, software, and services. But to be part of the Jobs club, you give up a certain amount of independence on everything from design to identity to pricing.

Jobs is upending two decades of conventional wisdom about the nature of competition in digital markets. Since the rise of Microsoft and Intel's "Wintel" PC standard in the 1980s, the assumption has been that markets would be dominated by those that could set technical standards—say, Microsoft in operating systems or Intel in microprocessors—and then benefit as thousands of others competed to build products on top of these "platforms."

But Apple's strategy is far simpler: Focus on making the best product, and rewards will follow. In fact, Apple's new partners are signing up in spite of, rather than because of, Jobs' rules of engagement. Apple makes little pretense of building a level playing field, but routinely picks favorites—such as Google for building mapping and video applications for the iPhone. And rather than aim for the most partners, Apple focuses on attracting the best ones. As a result, the Mac and iPod feel more like a gated, elitist community, with Apple keeping close watch over who gets in. "The notion of a platform is a very PC-oriented way of looking at the world," says Silicon Valley financier Roger McNamee. "Consumers just want a great experience. They don't buy platforms."

Consider how Apple changed expectations about portable music devices. There were plenty of MP3 players around before the iPod arrived in 2001. Now, if the iPhone works as advertised, it could similarly redefine the mobile-phone experience. As any BlackBerry or Treo owner knows, all of the 25 million smartphones sold last year offer similar capabilities, such as Web browsing and e-mail. But none has captured the heart of the mainstream consumer. And on paper, at least, the iPhone erases myriad frustrations faced by hundreds of millions of phone users—from maddeningly complex menus, to the inability to find a contact while on a call.

Spin it out a few years, and it's not hard to see why many companies want to be on Apple's side. iPhone buyers now sign up for an AT&T cellular package via iTunes. In the future, maybe they'll also be able to sign up for all the broadband and data services needed to power their Macs, iPods, and future Apple products (can you say: "I want my Apple iHomeTheater"?) and make them work together. That would play to Apple's strength—making the complex simple. "What you end up with is a kind of Apple archipelago—this cluster of islands in this big digital sea that are great places to hang out," says Silicon Valley futurist and consultant Paul Saffo.

Of course, Apple's products have to continue to delight—a real question for the iPhone, which doesn't even have a physical keyboard. But if Apple succeeds, it could raise itself and its ecosystem above the cacophony of industry giants now battling to "own" the digital consumer. The telephone and cable companies try to take advantage of their control of customers' access to video, data, and voice content. Google Inc. (GOOG) and Yahoo! Inc. (YHOO) want to leverage their power as online concierge for millions of consumers. Apple comes at it from the device perspective: If it can control the gadget you use to connect with all those other platforms, it increases its control over what you do, and how much you pay (99 cents a song, for example).

There are lots of phone carriers and cable companies, each with fairly similar offerings. Google and Yahoo are powerful in their own right, but they can't totally control their destiny since Web users are a click away from using another search engine or portal. For now, though, Apple is head and shoulders above others in making the actual machines you use to pull up Web pages, music, TV shows, movies, and soon, perhaps, phone conversations. Says David Sanderson, head of Bain & Co.'s global media practice: "We're moving from a distributor-driven paradigm to a consumer-driven paradigm—and Apple gets consumers."

And not just any consumers, but those who will pay a premium. The Mac is gaining share despite an average price tag of $1,400, nearly twice that of the typical PC. iPod shoppers still paid an average price of $181 in May, 15% above other music players. The iPhone is even more audaciously priced. The $499 base price compares with an average $66 for a regular phone, or $160 for a smartphone such as a BlackBerry or Treo, says NPD Group Inc. analyst Stephen Baker.

THE COMPATIBILITY FACTOR

None of this would have come about if Jobs hadn't had his epiphany about reaching out beyond the insular world of the Mac. The Office deal was a symbolic first step, but the real wake-up call came with the 2003 decision to do a Windows-compatible version of iTunes. Rather than hurt Mac sales, as some feared, this opened the floodgates on iPod sales by making the device usable by the 98% of computer users who ran Windows. Another milestone came when the company switched from PowerPC processors made by IBM (IBM) to Intel's far more popular chips. This made it possible for Macs to run Windows (an important insurance policy to many Mac newbies) and made it far easier for software developers to adapt their programs for Apple's products.

Consider the perspective of one big video-game producer, Electronic Arts. In the early 1980s, about half of the people working at EA's Redwood City (Calif.) campus were Apple alumni. Yet EA stopped making Mac-compatible games later in the decade, when Apple turned its attention to corporate markets. EA co-founder Bing Gordon recalls his shock when Apple's then-CEO John Sculley said in 1987 that "there is no home-computer market." Says Gordon: "They were working so hard to get respect, the last thing they wanted was for people who wore suits to think of the Mac as a toy." Predictably, game sales on the Mac plummeted, making it even less worthwhile for EA to make the big investments to adapt its PC games to run on the Mac's unique innards.

But because today's Intel-based Macs don't look much different from any Windows PC from EA's perspective, Gordon says it should be cheaper to churn out Mac games than, say, adapting them to game consoles like the Sony (SNE) PlayStation or Nintendo (NTDOY) Wii. With the Mac rapidly gaining share with younger shoppers, EA has announced plans to release its new Harry Potter game and three other titles on the Mac this summer.

Another rarely mentioned advantage is Apple's so-called developer program. Once iPod sales began skyrocketing in 2003, the company worked with makers of portable speakers, music-player cases, and other add-on gadgets. And Apple is working on the most mobile platform of all. Since BMW first added an optional iPod connector in the glove compartment of many of its 2004 models, carmakers including Chrysler (DCX), Ford (F), and Honda (HMC) have followed suit. General Motors Corp.'s (GM) 2008 Cadillac CTS will come with a center console that features the iPod's "rotate and click" interface, not only for pulling music off an iPod but also for playing the radio or listening to CDs or satellite radio. "It's about getting to your music, not having to learn a new set of tricks for each service," says James Grace, the 27-year-old GM manager who leads the project.

With the iPhone, Apple seems ready to open up opportunities for software developers who were mostly shut out from the iPod. On June 11, it announced that any Web 2.0 program designed to work with Apple's Safari browser would work on the iPhone. That means such popular sites as MySpace, Digg, or Amazon.com will be able to adapt their services to take advantage of the device—say, by adding a virtual button on their sites so that iPhone users could actually place a phone call with a fellow Netizen, rather than just trade e-mails or post messages.

To be sure, many developers gripe that this approach is a far cry from letting them create applications designed from the ground up to work directly with the iPhone. That's a privilege Apple has conferred on only a few partners, such as Google. But "it's a good first step," says Digg Chairman Jay Adelson, who expects Apple to become more inclusive as time goes by. "For now, it's a very strange kind of controlled system—because they have these insanely high bars [for reliability and user experience] that they want to hit."

Many partners won't wait for a formal invite. Despite doubts about the iPhone's usefulness to serious businesspeople, Salesforce.com is working on an iPhone version of its sales management software. "It's not just about market share, it's about showing what is possible and what is cool," says CEO Marc Benioff. And more than 150 developers have registered to attend an ad hoc "iPhone Developers Camp" in San Francisco on July 6, to trade ideas and create new applications.

But if the Apple orchard is growing, it is still no Eden. For those partners that make the cut, Apple enforces a brutal perfectionism. "The stereotype is that they're this loosey-goosey California company, but nothing could be further from the truth," says Gary Johnson, the former CEO of chipmaker PortalPlayer Inc., which roared to prosperity by providing the electronic brains of the first generations of iPods. Johnson says that whenever a project fell off track or a part fell short of Apple's needs, its engineers were demanding "root cause analysis" and explanations within 12 hours. "You could pacify other customers by putting 10 engineers on a plane to see them. Not Apple."

`AN UNREASONABLENESS'

Working with Apple can be exhausting. Johnson says the company almost never issued documents outlining its technical requirements, preferring to keep things oral to avoid a paper trail that might be leaked. And no supplier was given a full picture of what exactly Apple was working on: Everything was on a "need to know" basis. "There's an unreasonableness," says Johnson. "It's as though your entire reason for being is to serve them." Yet he adds he has no hard feelings: "It wasn't a malicious thing. It's almost machine-like. You may have friendships or business relationships, but they don't really count." Johnson found that out on an April morning in 2006, when he learned Apple had decided not to use a chip that had been under development for more than a year and was expected to bring in half of PortalPlayer's sales. The company's stock crashed 50% when Johnson told Wall Street a few days later. Seven months later, it was purchased by Nvidia Corp. (NVDA) for $357 million—half of its peak market cap.

Suppliers of TV shows, movies, and other video content have their own reasons for being wary of joining the Apple ecosystem. They know what happened in the music industry. Jobs created a kind of reverse razor-and-blades model with the iPod, where Apple sells lucrative razors (music players) and the studios are stuck selling cheapo blades (music). Hollywood has resisted Jobs' vision for placing movies on the iPod and iPhone. Only movies from Walt Disney Co. (DIS) (where Jobs is the largest individual shareholder) and Paramount Pictures (VIA) have licensed movies to iTunes. The 52 million TV shows and movies sold so far by Apple amounts to fewer than two videos per iPod.

This makes Apple's newest partnership with AT&T (T) for iPhone service all the more intriguing. Since the iPhone was announced in January, many observers have wondered if Jobs pulled another fast one, using his consumer cred to win unprecedented influence over the $140 billion cellular-phone business. Normally, carriers in the U.S. control how cell-phones are priced and marketed, right down to deciding whether they will turn on capabilities built into the phones, such as wireless music downloading. But that's not how Apple rolls. Apple defined the 16 services that are highlighted on the iPhone homepage, and users sign up for them via iTunes, not on AT&T's homepage or in its stores.

Has AT&T set itself up to be marginalized? The carrier stands to steal subscribers from its rivals; CEO Randall L. Stephenson said on June 19 that of the 1.1 million people who had inquired about the iPhone, 40% were not currently signed up with AT&T. But analysts say Apple will earn a luxurious 35% gross margin on each of the $500 devices. AT&T is offering a $59 base plan for phone and data services—roughly $20 less than the cost for corporate e-mail devices like Treo. Besides potentially taking a bite out of AT&T's margins, this could cause its other handset makers to demand sweeter deals, too.

But the real test will be whether Jobs can change the way consumers think about a phone. This is Apple's first entry into a preexisting mass market, and those other phone manufacturers can't afford to let Jobs rewire things to suit Apple's strengths. Some already have rolled out cheaper products that, if not exactly as capable as the iPhone, may be close enough. Will most consumers eventually choose to save money, even at the expense of a bit of elegance? History says they will, according to Harvard Business School professor Clayton M. Christensen: "The world always ends up thanking innovators for their cool products—but won't pay for them. There are forces of gravity at work."

Now there's a matchup worth watching: Steve Jobs vs. gravity.

By Peter Burrows


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