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When the Tail Outgrows the Dog Steven Spadt Marketing 421-001 Suzanne Diamond The Wharton School April 3, 2006            

BACKGROUND Apple has clearly had their ups and downs.

In the 1990s, they grew success from embracing their status as the “alternative” to the mainstream PC option, the so-called “Wintel” machine, by offering the stylish, rebellious iMac. After a couple of years of success, though, they started to lose their grip on their niche markets as their big-money competitors swarmed to minimize their impact by offering lower-priced, higher-powered options. In 2005, the tables have turned and with their ubiquitous iPod portable music player, Apple finds themselves in the position of dominant market leader, seeking to maintain their dominance and build upon the iPod’s success and put an end to their cyclical corporate strength. Apple once again has a winner. The task before them now is to find a way to simultaneously sustain their success in the portable electronic device market while also leveraging it to gain ground in their core marketplace, personal computing.

Apple Case – Spadt

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SITUATIONAL ANALYSIS Positioning the Apple Image Since its early days on the personal computer (PC) scene, Apple has embraced and capitalized on its rebellious image. Apple created, controlled, and to the joy of their loyal following, successfully marketed their alternative to the conglomerate of the Microsoft™ Operating System, Intel processors, and big business hardware manufacturer’s like IBM (the so-called “Wintel” machines). The alternative that Apple offered—based on the Macintosh Operating System (MacOS)—was a bundle of software applications and hardware that was and continues to be unparalleled in style and substance. While Wintel machines were positioned as efficient, cost-effective tools, Apple’s were positioned more as expressions of their creative owners’ personalities. While the detailed technical differences in the PC systems were known largely only to the application developers, consumers knew that a purchase of an Apple product was a contribution to the alternative—an investment in a company that did things the right way, if only because they did things differently than the big companies like IBM, Microsoft, and Intel. The challenge in managing this image going forward is that, with respect to personal music players, Apple is the big company. Apple owns the market with the iPod device and the iTunes service. There is a need to preserve their identity as the alternative to Microsoft and the Wintel corporate machine in the personal computing market while clearly defininig and embracing their dominant position in the personal music player space. To exist as both the alternative “underdog” in the PC market and the ubiquitous champion in the personal music market will be challenging and will require some unique approaches. However, as the line between PCs and portable computing devices blurs, both positions may be in need of some refreshing. Apple’s target segments remain: ƒ ƒ ƒ

Apple Case – Spadt

Apple Loyalists – Apple customers who are firmly entrenched and are not likely to consider non-Apple products New Users – Consumers who will enter into a reasonably unbiased assessment leading to a purchase decision Windows Switchers – Wintel loyalists who make the leap to join the community of Apple owners Page 2 of 10


The question is, what energies (resources) should be allocated to each of these segments, and are they still relevant, given all of the other changes in the consumer technology marketplace? Apple must endeavor to leverage the success of iPod to gain additional Mac customers and potentially lessen the Wintel stronghold on the PC market by reducing the demand for the traditional PC, itself. Product Definition The iPod product is more than a portable music player. The iPod is actually a bundle of product components that consist primarily of the pocket-sized iPod player device, the iTunes digital music delivery service, and the client player (software) that runs on the “host” computer, allowing users to play back music on their PC as well as facilitating transfer of downloaded music to their iPod device. A PC is truly a system consisting of multiple components (system hardware, peripheral hardware, Operating System software, application software, and bundled services). The iPod fits the system model as well, with several notable components that have no parallels in the PC: the host PC, itself, the iTunes service, and a wealth of accessory opportunities. The current iPod devices are dependent upon a host computer, running a specific software application (iTunes) to get music files on and off the device. The following table charts the comparisons between PC computer system components and components of the iPod portable music system.

PC/Desktop Computer System hardware (box) Peripherals (printer, keyboard, mouse, etc.) Application software Operating System software

Apple Case – Spadt

iPod The device, itself Attachments (headphones/ear-plugs, digital camera, etc.) Music/photo browse and playback interfaces System software, including music file encoder/decoder, etc. “Host” computer + iTunes client application software and desktop player

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iTunes “service” Accessories (cases, belt clips, “skins,” etc.)

The definition of the iPod product, then, becomes increasingly difficult as we attempt to define the roles played by each component of the system. An iPod, itself, is a portable music player (though an extraordinarily well designed one). Adding iTunes, attachments and increased capabilities such as those offered by the iPod Photo version, and then wrapping the entire system in an Apple-branded package is an attempt to bundle the services, software, and device into a single, coherent whole. And the uniqueness of that whole---the “lure” of the Apple brand—is built on a few key ingredients, shared by each component in the system (iPod, iTunes, and the host computer): 1. Intuitive User Interface – Apple’s designers are legendary for their design of intuitive user interfaces, from their creation of the first “windows”-based computer interface to their innovative use of the iPod “dial.” 2. Simplicity of Design – Often the antithesis of their main rivals, Microsoft, Apple focuses on simplicity rather than complexity. No machine should be more complicated than it needs to be. 3. Stylish Presentation – Sometimes accused of being too concerned with the packaging, Apple never cuts corners aesthetically. Every Apple product confirms that form need not take a back seat to function, reflecting the creative personalities of their owners. Diffusion of Innovation – Making Waves During the early portions of the iPod life cycle, Apple successfully overlayed new benefits (some, legitimate innovations of their own) to prolong the peaks and create opportunities for new adopters. Offering new innovations increases the total potential market for the new devices since both late adopters of the iPod who have not yet adopted and early adopters (who will become early adopters of the latest models) may be targeted. Especially considering that adopters may be included on any number of the curves (innovators, for example, may be on all of the curves), Apple has begun a pattern of delivering cyclical innovations to maximize adoption potential. As long as the new models continue to be true innovations, rather than model tweaks like greater song capacity, new colors, etc., this approach may be sustainable.

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iPod Innovation(s) – Cyclical Life Cycles % adopting

Original iPod iPod Photo

U2 iPod

iPod Shuffle

?

Mapping the models to benefits, we see: Original iPod: Ability to listen to your favorite music anywhere, all accessible via an incredibly intuitive device in an expressive, stylish package iPod Photo: Ability to store and show your favorite photos from the same device you already carry for your music U2 iPod: Unprecedented social status and connection of users to popular, socially conscious icons iPod Shuffle: Optimal portability (size of pack of gum), available at entry-level prices Changing Environment – Device Convergence We only have so many pockets, but the number of devices we want to carry with us continues to increase with each new offering in the portable consumer electronics marketplace. Because of this phenomenon, and the need for each of our portable devices to work together, the lines between the primary categories, personal digital assistants (PDAs), cell phones, and digital music players, is blurring. Indeed, if a single device could provide all of the funcitionality in a single, easy-to-use, powerful, compact, and stylish package, it would likely garner significant attention. As depicted below, the makers of each of the major device classes have been moving to expand the benefits of their individual

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offerings to achieve this. The PDA and cell phone markets, however, are substantially more fragmented than the music player market. No player in any of the other markets has achieved the dominance that Apple has with the iPod.

PDA

Cell Phone

Music Player

In addition to the convergence of mobile devices, there is a convergence of another sort taking place. Home entertainment systems (also called media centers) are increasingly being converted from dependence on CDs and other digital media to utilizing digital music formats like those stored on portable music devices. In fact, the iTunes service is not limited to serving songs to mobile music listeners—the same file can be utilized by home systems that are properly equipped, connected to PCs that serve as the “hubs” in the home music system. Looking beyond music to home entertainment as a whole, digital video continues to gain ground, but bandwidth limitations limit the amount of video that can be stored on a portable device to several hours at a time. The other factor effecting potential adoption of portable video is that, while portable music suffers no loss in the quality of the experience, the enjoyment of video content is directly related to screen size, something obviously lacking on a portable device. Portable video is a market that will likely increase in the coming years, but unlike with music, the separation between home video playback and portable video playback is distinct. The two

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markets are inherently separate, so if Apple seeks to embrace one or the other, they’ll need to do so with separate efforts. On the personal computing side, the Mac Mini hits the right price point ($499) and is targeted directly and unabashedly at the coveted “Windows switchers.” The idea is to allow Wintel users to keep their existing displays, keyboards, and mouse devices while converting to the MacOS platform for almost half the cost of upgrading to the latest Wintel system. The missing ingredient in the Mac Mini, though, despite its miniature size, is portability. Even though the box itself can fit in the palm of a hand, when the display, keyboard, and mouse devices are added, the result is a decidedly non-portable system. So the Mac Mini, despite its name and size, is firmly entrenched as an alternative desktop solution, not a solution to increase the mobility of personal computing consumers.

Going Mobile Whether consumers are more on-the-go than in the past or whether they simply want to take more with them, consumers seem to be demanding more functionality when they are away from home. Comparing the merged sales of laptops (PowerBooks and the newer iBook models) with traditional desktop computers (PowerMacs and the newer iMacs), 2004 saw a remarkable occurrence. Mobile computers from Apple actually outsold Apple desktop machines. This certainly appears to indicate that mobility is a benefit in which personal computing consumers are placing an increasing value. Sales of Apple Products (2002 – 2004)

2900 2700

Mobile (PowerBook/iBook)

2500 2300

Desktops (PowerMac/iMac)

2100 1900 1700 1500 2002 Apple Case – Spadt

2003

2004 Page 7 of 10


Within the target consumer electronics sector, mobility is playing no less of a role in purchase decisions. Clearly, with iPods achieving ubiquity status in the music device market and mobile computing system adoption outpacing that of traditional desktop-tethered systems, the value placed on mobility by today’s consumer appears stronger than ever, and does not appear limited to the domain of music, but is applied broadly to personal computing, as a whole.

CONCLUSIONS Apple competes in several different markets, dominating in one, and playing a financially minor, though market-significant, niche role in another. The challenge before them is to effectively lengthen their iPod tail and use its strength to wag the rest of the Apple dog. The answer is to connect iPod’s benefits (brilliant user interface, simplicity of design, stylish and expressive presentation) to the host machine and embrace today’s cult following of the iPod as tomorrow’s Apple customer base. As Steve Jobs himself acknowledged, it is difficult to make substantial profits from an online music service, itself. While the iTunes service is a crucial component in the iPod system, it can not preserve Apple’s current levels of profitability, alone. The service needs to remain central to the system, in which lies the profits, through sales of devices, accessories, and it is hoped, host computers made by Apple—all delivering the core Apple benefits. The sustainability of the strength of the iPod system, itself, will depend on the continued introduction of dynamically continuous innovations. New innovations can take the form of next-generation iPod devices (offering new benefits like portable photo management/display), next-generation iTunes and related services, or the connection of either of these to the host computer. The iPod is a system, and innovations must focus on all the components to be successfully diffused. Convergence of devices goes beyond PDAs and handheld devices to the convergence of computing technology, itself. Even traditional PCs are at risk, at least within the home/consumer segment, as the demand for mobility forces new form factors like TabletPCs and socalled micro-notebooks to be introduced. Hybrids between traditional laptop computers and handheld devices like cell phones and PDAs are already starting to battle for space in the converging

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markets. The challenge for Apple is to determine just where the iPod and their iBook machines fit into the convergence mix. It is possible, for example, that iPods could not only be provided with basic PDA features, but with wireless connectivity as well. This would effectively eliminate the host computer entirely from the loop, as a smaller version of iTunes could run directly on the iPod. The impact of portable digital music formats on home music listening is increasing, as well. Because the capacity of iPod devices continues to well outpace the size of most users’ music collections, it is conceivable that users could store their entire collection on their iPod and utilize it as the “hub” in a home music system. A system that would allow a user to plug an iPod into an amplifier/speaker setup could further carve out market position of existing iPod users as well as drive non-iPod users to the Apple platform. The iPod system could be re-positioned from simply a portable music player to a personal music collection.

RECOMMENDATIONS Recommendation 1: Develop the mobile equivalent of the Mac Mini, priced low enough to compete with other sub-notebooks, and bundle it with the latest iPod device (see Recommendation 2 below), iTunes service, and wireless connectivity. This product, potentially called the “iMob,” (from iMobile) would be positioned as the total solution for mobile computing. The machine itself would compete directly with Wintel equivalents termed “sub-notebooks” and small TabletPCs, but the all-in-one solution for portable computing coupled with wireless Internet access would position the product uniquely in the market, while capitalizing on the popularity and usability advances of the iPod. More importantly, it could serve as the trigger for transitioning iPod adoptees still on the Wintel platform to adopt the MacOS for the benefits learned from their iPod experience.

Recommendation 2: Develop a premium iPod (iPod “UNO” – indicating an all-in-one device) that meets the market’s demand for device and service convergence. Follow the lead of PDA makers like Palm and RIM and partner with wireless carriers to offer an iPod that offers basic cell phone and basic PDA features, all in one iPod-branded package. Keep the cell phone and PDA features very basic, to avoid adding too much complexity, but position the product as an

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alternative to carrying 3 different devices—the coveted converged device. Design the device to synch only with MacOS hosts, such as the iMob (see recommendation 1), at least initially, to skim the innovators and early-adopters and drive Mac sales.

Recommendation 3: As a lower priced alternative to the iPod “UNO”, consider partnering with cell phone manufacturers and/or carriers to enable local wireless communication between cell phones and specially configured iPods to allow wireless downloads of songs via cell phones. Local wireless networking technologies like BlueTooth® enable devices to communicate with each other. Utilizing this or a related technology, iPods could receive downloaded songs from cell phones (that would be configured to run a special mobile version of iTunes), eliminating the need to connect the iPod to a host to receive new songs. Market the device to Wintel users, who would not initially be able to synch the “UNO” to their computers, and to more price-sensitive consumers.

Recommendation 4: Continue to pace additional iPod innovations to lure lateadopters and encourage existing iPod customers to additional purchases at a wide variety of price points. Possible innovations include: - a digital camera add-on that would connect to the iPod Photo edition and all subsequent iPod versions with color displays - digital video playback capabilities - additional partnerships with music artists (Iike the U2 partnership) to produce and deliver customized, branded content

Recommendation 5: Partner with one or more home music system manufacturers, license the iTunes song format, and position the iPod as a “personal music collection” hub for their home music systems. Invite consumers to “carry their personal music collection with them wherever they go, and plug it in when they get home.” To further guard against Microsoft’s moves to position competitive song file formats as cheaper alternatives, consider bundling packages of iTunes song downloads with the home music systems. Even if per song profits drop below zero, as long as iTunes songs can only be played on Apple devices and partners’ home music systems, profits made on device sales would overcome expenses.

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Apple Case Study (Marketing Certificate Program, 2006)