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Strategic Management Case plus Case Answer – Apple’s Profitable but Risky Strategy

Case study

Apple’s profitable but risky strategy

When Apple’s Chief Executive – Steven Jobs – launched the Apple iPod in 2001 and the iPhone in 2007, he made a significant shift in the company’s strategy from the relatively safe market of innovative, premium-priced computers into the highly competitive markets of consumer electronics. This case explores this profitable but risky strategy.

Note that this case explores in 2008 before Nokia had major problems with smartphones – see Case 9.2 and Case 15.1 for this later situation.

Early beginnings

To understand any company’s strategy, it is helpful to begin by looking back at its roots. Founded in 1976, Apple built its early reputation on innovative personal computers that were par-ticularly easy for customers to use and as a result were priced higher than those of competitors. The inspiration for this strategy came from a visit by the founders of the company – Steven Jobs and Steven Wozniack – to the Palo Alto research laboratories of the Xerox company in 1979. They observed that Xerox had developed an early version of a computer interface screen with the drop-down menus that are widely used today on all personal computers. Most computers in the late 1970s still used complicated technical interfaces for even simple tasks like typing – still called ‘word-processing’ at the time.

Jobs and Wozniack took the concept back to Apple and developed their own computer – the Apple Macintosh (Mac) – that used this consumer-friendly interface. The Macintosh was launched in 1984. However, Apple did not sell to, or share the software with, rival companies. Over the next few years, this non-co-operation strategy turned out to be a major weakness for Apple.

Battle with Microsoft

Although the Mac had some initial success, its software was threatened by the introduction of Windows 1.0 from the rival company Microsoft, whose chief executive was the well-known Bill Gates. Microsoft’s strategy was to make this software widely available to other computer manufacturers for a licence fee – quite unlike Apple. A legal dispute arose between Apple and Microsoft because Windows had many on-screen similarities to the Apple product. Eventually, Microsoft signed an agreement with Apple saying that it would not use Mac technology in Windows 1.0. Microsoft retained the right to develop its own interface software similar to the original Xerox concept.

Coupled with Microsoft’s willingness to distribute Windows freely to computer manufacturers, the legal agreement allowed Microsoft to develop alternative technology that had the same on-screen result. The result is history. By 1990, Microsoft had developed and distributed a version of Windows that would run on virtually all IBM-compatible personal computers – see Case 1.2. Apple’s strategy of keeping its software exclusive was a major strategic mistake. The company was determined to avoid the same error when it came to the launch of the iPod and, in a more subtle way, with the later introduction of the iPhone.

Apple’s innovative products

Unlike Microsoft with its focus on a software-only strategy, Apple remained a full-line computer manufacturer from that time, supplying both the hardware and the software. Apple continued to develop various innovative computers and related products. Early successes included the Mac2 and PowerBooks along with the world’s first desktop publishing programme – PageMaker. This latter remains today the leading programme of its kind. It is widely used around the world in publishing and fashion houses. It remains exclusive to Apple and means that the company has a specialist market where it has real competitive advantage and can charge higher prices.

Not all Apple’s new products were successful – the Newton personal digital assistant did not sell well. Apple’s high price policy for its products and difficulties in manufacturing also meant that innovative products like the iBook had trouble competing in the personal computer market place.

Apple’s move into consumer electronics

Around the year 2000, Apple identified a new strategic management opportunity to exploit the growing worldwide market in personal electronic devices – CD players, MP3 music players, digital cameras, etc. It would launch its own Apple versions of these products to add high-value, user-friendly software. Resulting products included iMovie for digital cameras and iDVD for DVD-players. But the product that really took off was the iPod – the personal music player that stored hundreds of CDs. And unlike the launch of its first personal computer, Apple sought industry co-operation rather than keeping the product to itself.

Launched in late 2001, the iPod was followed by the iTunes Music Store in 2003 in the USA and 2004 in Europe – the Music Store being a most important and innovatory development. iTunes was essentially an agreement with the world’s five leading record companies to allow legal downloading of music tracks using the internet for 99 cents each. This was a major coup for Apple – it had persuaded the record companies to adopt a different approach to the problem of music piracy. At the time, this revolutionary agreement was unique to Apple and was due to the negotiating skills of Steve Jobs, the Apple chief executive, and his network of contacts in the industry. Figure 1.9 shows that Apple’s new strategy was beginning to pay off. The iPod was the biggest single sales contributor in the Apple portfolio of products.

In 2007, Apple followed up the launch of the iPod with the iPhone, a mobile telephone that had the same user-friendly design characteristics as its music machine. To make the iPhone widely available and, at the same time, to keep control, Apple entered into an exclusive contract with only one national mobile telephone carrier in each major country – for example, AT&T in the USA and O2 in the UK. Its mobile phone was premium priced – for example, US$599 in North America. However, in order to hit its volume targets, Apple later reduced its phone prices, though they still remained at the high end of the market. This was consistent with Apple’s long-term, high-price, high-quality strategy. But the company was moving into the massive and still-expanding global mobile telephone market where competition had been fierce for many years. (Note that with regard to Figure 1.9, the new iPhone was too new to have made any impact on sales or profitability in 2007.)

And the leader in mobile telephones – Finland’s Nokia – was about to hit back at Apple, though with mixed results. But other companies, notably the Korean company Samsung and the Taiwanese company, HTC, were to have more success later.

So, why was the Apple strategy risky?

By 2007, Apple’s music player – the iPod – was the premium-priced, stylish market leader with around 60 per cent of world sales and the largest single contributor to Apple’s turnover – see Figure 1.9. Its iTunes download software had been re-developed to allow it to work with all Windows-compatible computers (about 90 per cent of all PCs) and it had around 75 per cent of the world music download market, the market being worth around US$1000 million per annum. Although this was only some 6 per cent of the total recorded music market, it was growing fast.  The rest of the market consisted of sales of CDs and DVDs direct from the leading recording companies.

[Insert Figure old 1.9 near here]

In 2007, Apple’s mobile telephone – the iPhone – had only just been launched. The sales objective was to sell 10 million phones in the first year: this needed to be compared with the annual mobile sales of the global market leader, Nokia, of around 350 million handsets. However, Apple had achieved what some commentators regarded as a significant technical breakthrough: the touch screen. This made the iPhone different in that its screen was no longer limited by the fixed buttons and small screens that applied to competitive handsets. As readers will be aware, the iPhone went on to beat these earlier sales estimates and was followed by a new design, the iPhone 4, in 2010.

The world market leader responded by launching its own phones with touch screens. In addition, Nokia also launched a complete download music service. Referring to the new download service, Rob Wells, senior Vice President for digital music at Universal commented: ‘This is a giant leap towards where we believe the industry will end up in three or four years’ time, where the consumer will have access to the celestial jukebox through any number of devices.’ Equally, an industry commentator explained: ‘[For Nokia] it could be short-term pain for long-term gain. It will steal some of the thunder from the iPhone and tie users into the Nokia service.’ Readers will read this comment with some amazement given the subsequent history of Nokia’s smartphones that is described in Case 9.2.

‘Nokia is going to be an internet company. It is definitely a mobile company and it is making good progress to becoming an internet company as well,’ explained Olli Pekka Kollasvuo, Chief Executive of Nokia. There also were hints from commentators that Nokia was likely to make a loss on its new download music service. But the company was determined to ensure that Apple was given real competition in this new and unpredictable market.

Here lay the strategic risk for Apple. Apart from the classy, iconic styles of the iPod and the iPhone, there is nothing that rivals cannot match over time. By 2007, all the major consumer electronics companies – like Sony, Philips and Panasonic – and the mobile phone manufacturers – like Nokia, Samsung and Motorola – were catching up fast with new launches that were just as stylish, cheaper and with more capacity. In addition, Apple’s competitors were reaching agreements with the record companies to provide legal downloads of music from websites –described in more depth in Case 12 at the end of this book.

Apple’s competitive reaction

As a short term measure, Apple hit back by negotiating supply contracts for flash memory for its iPod that were cheaper than its rivals. Moreover, it launched a new model, the iPhone 4 that made further technology advances. Apple was still the market leader and was able to demonstrate major increases in sales and profits from the development of the iPod and iTunes. To follow up this development, Apple launched the Apple Tablet in 2010 – again an element of risk because no one really new how well such a product would be received or what its function really was. The second generation Apple tablet was then launched in 2011 after the success of the initial model. But there was no denying that the first Apple tablet carried some initial risks for the company.

All during this period, Apple’s strategic difficulty was that other powerful com-panies had also recognised the importance of innovation and flexibility in the response to the new markets that Apple itself had developed. For example, Nokia itself was arguing that the markets for mobile telephones and recorded music would converge over the next five years. Nokia’s Chief Executive explained that much greater strategic flexibility was needed as a result: ‘Five or ten years ago, you would set your strategy and then start following it. That does not work any more. Now you have to be alert every day, week and month to renew your strategy.’

If the Nokia view was correct, then the problem for Apple was that it could find its market-leading position in recorded music being overtaken by a more flexible rival – perhaps leading to a repeat of the Apple failure 20 years earlier to win against Microsoft. But at the time of updating this case, that looked unlikely. Apple had at last found the best, if risky, strategy.

© Copyright Richard Lynch 2012. All rights reserved. This case was written by Richard Lynch from published sources only.[1]

 

Case questions

1    Using the concepts in chapter 1, undertake a competitive analysis of both Apple and Nokia – who is the stronger?

2    What are the problems with predicting how the market and the competition will change over the next few years? What are the implications for strategy development?

3    What lessons can other companies learn from Apple’s strategies over the years?

 

CASE STUDY: APPLE’S PROFITABLE BUT RISKY STRATEGY

Indicative answer only: there will be other answers to this case.

Note that these indicative answers really only make sense in the context of Chapter 1 of Strategic Management, sixth edition.

1. Using the concepts in this chapter, undertake a competitive analysis of both Apple and Nokia – who is stronger?

Relevant concepts in the chapter are mainly from section 1.1: value added, sustainability, processes to deliver strategy, competitive advantage, linkages, vision.

Apple strengths: Strong brand name, market leader in music delivery, user-friendly products, design skills, quality, exclusive contracts, profitable, strong vision

Apple weaknesses: High(er) price, limited distribution, small share of large phone market, features can be replicated over time.

Nokia strengths: Brand name, dominant position in mobile phone market, good products, profitable, strong processes to delivery new strategies

Nokia weaknesses: Mature phone market, little involvement in music market to the present, its new music service has no clear sustainable advantage.

Given Apple’s previous profit record, there is no doubt that it has benefited significantly from its move into recorded music and the iPod. However, the extension into Apple mobile telephones remained to be proven at the time of writing. It suddenly faced some very large companies – like Nokia – with both the resources and the desire to take advantage of the market opportunities.

Is Apple stronger than Nokia? In the short term, arguably the answer is that they both have their strengths. However, Nokia is just moving into the recorded music market and it has already produced its own version of the touch phone [with clear advantages over the iPhone according to one independent magazine review]. Thus it is worth clarifying the question of ‘who is stronger’ with respect to the time frame.

In the long run, it may be that Nokia will emerge stronger. At the time of writing, Apple’s strategy of premium pricing for its phone service had to be revised downwards – it simply was not hitting its sales targets. In addition, Apple managed to upset some loyal customers by introducing a new version of its phone that had more features and was also lower-priced. Apple does not look like a company that is strong in the mobile phone market.

But Apple had one great competitive advantage: its technology and software were superior – i.e. more user=friendly – than Nokia. The Finnish company understood the competitive threat from the new smartphones but failed to recognize that its software was not up to the task. Even in 2013, Apple has not taken a dominant share of the mobile phone market, but it is highly profitable.

By contrast, Nokia is really struggling. You can read about Nokia’s strategic problems in Chapter 9, Case 9.2.

Importantly with regard to assessing who is stronger, it is essential to identify the uncertainties in the market place – new technologies, responses of consumer electronics companies, etc. These should add up to major doubts as to how the market will develop. This then raises the question of what strategy to adopt – an emergent strategy is essential.

2. What are the problems with predicting how the market and the competition will change over the next few years? What are the implications for strategy development?

The main problems relate to the uncertainties of new technology and the difficulty in predicting how these will be exploited. An additional problem is the degree of economic uncertainty that may impact on customer ability to buy phones. The implications for strategy development relate to the difficulty in using prescriptive processes in this strategic context.

3. What lessons can other companies learn from Apple’s strategies over the years?

Lessons in at least five areas:

  1. The benefits of being an innovator and the risks attached with that strategic route – the iPod itself and the rivals now entering the market.
  2. The need to build on the competitive advantages of the company if possible – the Apple brand name, user-friendly software design, etc.
  3. The importance of understanding your customers and their needs – the desire of its young target group to have a large album list available along with the ability to augment this legally.
  4. The value of taking market-based opportunities in order to launch new products – the recorded music market/download market was arguably ready for this new product and Apple’s timing was good.
  5. The difficulties that can arise as companies move out of their existing product ranges and begin to compete in other markets – the move into the wider area of consumer electronics and mobile phones, as explained in the case.

[1] References for Apple case: Apple Annual Report and Accounts for 2006 and 2010. Website: www.apple-history.com/history. This website provides much more detail than the case and would be good for student research. Financial Times reports: 29 April 2003, p31; 6 April 2004, Creative Business Section, p3; 30 April 2003, p22; 14 October 2004, p29; 19 November 2004, p13; December 2004, p31; 11 January 2005, p26; 12 January 2005, p27; 21 January 2005, p12; 15 February 2005, p1; 16 February 2005, p27; 3 April 2006, p3 of global brands supplement; 4 December 2006, p11; 5 July 2007, p22; 29 August 2007, p21; 7 September 2007, p23; 26 September 2007, p27; 24 October 2007, p21; 5 December 2007, p28; 16 January 2008, p24.

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