The conventional wisdom in high-tech is that making hardware is a grubby, low-margin business and that software is as close to printing money as you can legally get.
In the past year, Apple had already surpassed Microsoft on benchmarks such as market cap and quarterly revenue, but topping them profit-wise is the most significant yet. With all of the pent-up demand for the iPad 2 due to Japanese disaster-related delays, Apple’s near-term profits will only increase.
As we all know, Apple makes all most of its money selling hardware. Microsoft makes about 85% of its revenue selling software (about 10% comes from selling Xbox and Kinect hardware, the rest comes from the money-burning online division).
That a hardware vendor could be more profitable than a software vendor, especially one with multiple franchises with steady revenue streams from corporations (Windows, Office, Exchange, SQL Server, SharePoint, among others), is incredible.*
Still, I don’t consider Apple bigger profits ($5.9 billion versus Microsoft’s $5.2 billion) a triumph of hardware over software. Hardware remains a dog-eat-dog business. That’s why HP and Dell are moving away from PCs towards software and services, while IBM totally got out of them.
Software, provided it is not open-source, remains much easier. What I think this shows is a triumph of a third factor: good design.
By design, I don’t just mean trendy materials or beautiful hardware shells or cute icons. The artsy stuff that employs graphic designers. That’s key to the Apple magic, but it’s only the top level stuff.
What I mean is intuitive user interfaces, tight integration between hardware and software and OS, and a control freak attitude towards your partners’ quality control (i.e. developers in Apple’s App Store). That’s the deep stuff that most tech vendors, due to their reliance on not-always dependable partners, can’t duplicate.
The conventional wisdom about why Jobs almost killed Apple‘s decline and Microsoft’s rise1995 timeframe was that hiJobs’ hardware fetish blinded him to the potential value of licensing the Mac OS to other PC manufacturers in the early 1980s, which would’ve allowed Apple to gain some/all of the profits that Windows got instead. When Jobs returned to Apple in 1997, he killed the Mac OS licensing program that had only been started two years earlier under CEO Michael Spindler.
I have an alternative explanation. Jobs actually overvalued the Mac OS, in the sense that he believed that controlling both hardware and software was the only way he could control the third factor, design, and turn out the best products he could.
As Apple’s success today shows, Jobs’ attitude is perfect for today’s mature hardware market, where differentiating what have essentailly become commodity products through good design/usability is the way to huge profits. It would also carry over well to mature consumer electronics markets like TVs or stereos, which is why Apple is so often rumored to be moving into those markets (Bose has employed this formula so well).
Unfortunately, Jobs’ attitude was woefully out of step with the market 20 years ago, when PCs were new and expensive. Consumers weren’t yet jaded and looking for the radically-designed, beautiful thing – they were just trying to get their hands on a PC for a decent price. Perfectionism doesn’t scale.
Also, Jobs’ attitude clashed with IT buyers. To a CIO, a computer that was too attractive or cute radiated a lack of seriousness of purpose. Mainframes are about as opposite from cute as you can get.
Today’s enterprise IT market is far different. Cloud computing empowered the line of business manager to go around the command-and-control CIO. That, and the recession’s curb on capital budgets, has forced many CIOs to adopt ‘Bring Your Own Device’ policies and open the door to employee-owned smartphones, laptops and now tablets.
It means that consumer preferences will soon start to rule many aspects of enterprise IT. And that can only mean more good news for Apple and Jobs, as well as companies like Sybase and our parent SAP, who are putting an emphasis on usability and design (see this blog post by Timothy Clark on the ‘gamification of business apps.’)
In other words, vendors need to think of themselves as being in the user experience/design business rather than either the hardware or software business. After all, what is providing a good user experience but another way of saying that you want to provide good customer service?
*To be pedantic, Microsoft still has a higher net profit margin than Apple: 32% vs. Apple’s 24%. But as SAI’s Matt Rosoff pointed out, 24% is “unbelievable and spectacular for a hardware company.” Microsoft’s 32% is good but not so unexpected because “software has a much lower cost of goods – once you’ve recovered your R&D investment, every sale is pure profit.” And expect Apple’s quarterly profits to continue to beat Microsoft’s.