Marginal Improvements

As a product gets better, the additional, functional benefit of each product improvement tends to get smaller. Certain product functions become good enough. Continued improvement of these good enough functions: (1) isn't valued as highly by consumers, and may not be enough to convince consumers to upgrade to the latest product version; and (2) leads to over-complex, overserving, overpriced products that only appeal to the most demanding users, ultimately hurting a company's sales and profits.

It also seems like products hit a point at which they can't be meaningfully improved in their current form. When this happens a product's form/shape has to change to stimulate sales. PC's are good enough and hard to improve further, leading to stagnating PC sales, yet computing products have continued to grow through different forms like tablets and smartphones. 

Product functions that aren't good enough are the ones a company needs to focus on, because improvement in these areas motivates consumers to buy the improved product.

When functionality is generally good enough, it's time for a company to: (1) start improving product access and affordability, making it easier for consumers to acquire and use the product; and (2) start exploring new product forms where improvement will be valued.

Dead Simple

Mass market consumers generally want a product to be as simple as possible. That's why defaults are so important, and why "the best" isn't necessarily the most widely adopted. Simplicity is also an important performance attribute for companies to improve on -- improving a product by making it simpler and simpler to use, often by removing unnecessary, unused features. This is an area where companies with established products often seem to go wrong: they add unused features or functionality and never strip this cruft away despite poor user adoption. Overserving, over-complex features or functionality leave the door open for entrants to introduce a simpler, better-designed, less expensive product that's more useful.

Certain questions seem especially relevant in assessing an incumbent's ability to avoid low end disruption while also creating dead simple products that create new markets:

  • Are the incumbent's formerly simple products becoming more complex and weighed down with unused features?
  • Is the incumbent trying to improve the simplicity of its products by removing unused features, even as it tries to add valued functionality?
  • Is an entrant having success with a simpler, less expensive product that only focuses on the essential? Is the incumbent ignoring this success or trying to compete with its own simplified offering?
  • Does the incumbent appear committed to creating simple, well-designed products that either compete in the low end or create entirely new markets, even if it cannabilizes existing products that are more complex?

New (Sometimes Great) Products and Bad Businesses

You often see companies release a great, innovative product that's not profitable -- so the product eventually gets discontinued or the company goes out of business. Sometimes this is because the great new product incorporates technologies that are too expensive to sell in quantities sufficient to generate a bottom line profit. Or the product is sold in quantities sufficient to generate a profit but never goes beyond a niche market because of its high price -- incumbents aren't really threatened in this scenario.

Entrants with an approach that could be a low end disruption often face a similar problem: the company has a new, low cost way of addressing a job-to-be-done but never improves its product enough to accrue the pricing power needed to generate a profit. So the company hovers around breakeven profits and often goes out of business. 

Conversely, you see lots of low growth, "cigar butt" companies that persist with a mediocre but profitable product. These companies often survive -- and stay profitable -- despite pricier, technically superior new products or new, low cost approaches to the problem. In fact, the company with the superior, pricey product or the innovative low cost approach is often the one that goes out of business, while the cigar butt company continues operating. So a superior new product or low end approach doesn't necessarily translate into a "good business," sometimes because the new offering/approach is too expensive or overserving or can't generate the profits needed for product improvement.

You could define a good business as one where the product/service targets the job-to-be-done well enough -- in terms of product quality, convenience, price, etc. -- for the company to sell the product at an attractive profit. An attractive profit is one where the return on capital employed (capital employed meaning working capital plus net fixed assets) is high enough to justify continued capital expenditures/investment. Otherwise continued investment is a waste of time, money, and talent that could be productively invested elsewhere. Innovative products or approaches that can't generate an attractive profit -- an attractive return on capital employed -- within a reasonable period of time may not be as promising as they first appear.

Getting Hamstrung by Legacy Services and Products

Ben Thompson at stratechery.com just wrote a thought-provoking article titled "Apple's Organizational Crossroads." In the article Ben says Apple should consider organizing its services into divisions with separate P&L's, creating a direct profit incentive to help it create better services and then rapidly iterate/improve these services. This would be a break with Apple's current functional structure, under which the company is organized around functions like design, engineering, marketing, and so on rather than by product division. 

I wrote a pretty lengthy response/rebuttal to Ben's article. Rather than rewrite the response I'm going to quote it in full:

I think Apple does iterate its services independent of hardware releases -- I get regular updates to iTunes and OS and iOS regardless of whether I purchase new hardware.

I like the simplicity of Apple's approach to services: when I buy the hardware I know it's going to come with certain core services I need -- mail, messaging, contacts, calendar, Pages, Numbers, etc. -- and I don't have to worry about getting nickel and dimed for service updates (which is what Apple would presumably have to start doing if each service had a P&L).

Conversely, as an end user I really dislike the way Microsoft is following a nickel and dime approach by trying to funnel me into a yearly subscription for Word, Excel, etc. -- and I'm finding I can get along without state of the art services from Microsoft. Apple's core services are good enough for me. If any core Apple service isn't good enough then I just buy the service/app from a third party -- no big deal.

I think Apple is actually doing a fair job monetizing most of its services through its hardware, iCloud backup, and iCloud storage. And while hardware monetization doesn't provide a direct incentive for Apple to improve its services, it does provide an indirect incentive: Apple wants to make sure its core services are generally liked and used, since that use keeps the buyer purchasing future Apple products.

It's strange but you don't seem to hear as much about Google Docs anymore, despite powerful direct incentives for Google to improve this service (such as collecting user data, generating ad revenue, etc.). I continue to see complaints on Twitter about the limitations of Google Docs. I'm not convinced incentives have to be direct to be effective.

Apple Music may not be as good as Spotify but it's good enough for me, as is the ability to purchase videos through the iTunes Store. Apple Maps is also good enough for me and continues to get better (despite Apple's lack of direct incentives to improve Apple Maps).

I really think Apple's focus on the integrated user experience is appropriate, because this approach puts the focus on the job-to-be-done. Focusing on the job-to-be-done helps keep prevent unused features and non-meaningful improvements to services that are already good enough (again, I'm thinking of Microsoft services here).

And referencing Steve Jobs, Jobs always said you have to start with the user experience and work backward to the technology. You could arguably take this line, change a few words, and say something like: you have to start with the user experience -- which by its very nature is broad and encompasses both a hardware and a services component -- and work backward to a holistic, well-designed solution which isn't tied to whether particular components of this solution are profitable.

This holistic, integrated approach is enabled by a functional organizational structure. I don't think I'd ever want Apple to abandon this approach and go to product divisions/silos and a bunch of separate P&L's where great, integrated solutions/products become almost impossible.

Going forward I believe Apple will try to make a profit on services that don't have to be tightly integrated with Apple hardware. Such services might include: App Store revenues, iTunes music/video revenues, and Apple Music. This list might also include iCloud backup/storage tiers, since this is a backend service that's arguably more standalone. The more standalone nature of certain Apple services may explain why Apple made iTunes and Apple Music available horizontally to users of Microsoft and Android hardware.

Much of this response suffers from anecdotal, first person bias -- my own experiences and opinions regarding the "good enough" nature of many Apple services may not hold true for others. Despite this, I suspect at least some Apple users feel this way.

The Problem with Legacy Products/Services

After mulling around Ben's article and my response, it occurred to me that the Apple services struggling the most -- in terms of quality, complexity, and general cumbersomeness -- are the legacy ones. iTunes and Apple Music are confusing and complex because they still provide users like me with the legacy stuff I bought a few years ago (downloaded music, for example) while also giving me access to newer technologies/approaches like music streaming. iCloud can be confusing and cumbersome because I used to back things up to my computer and iTunes rather than backing up with iCloud. iPhoto can be confusing and cumbersome because Apple is trying to accommodate users who sync with their computers while also encouraging users to start using iCloud to save all their photos and videos.

I don't think the main thing holding up improvement/iteration of these Apple services is the absence of separate service divisions, each with a separate P&L. I think the main problem is the pre-existence of legacy solutions -- e.g., downloading and syncing music in iTunes or syncing photos with iPhoto on your computer -- that were developed before cheap cloud storage and high speed broadband became widely available. These legacy problems would exist regardless of whether Apple used a separate P&L for each service.

The Apple services without significant legacy issues seem to iterate/improve pretty rapidly. Apple Maps has no legacy issues and has rapidly improved. Apple services like contacts, calendar, notes, Pages, and Numbers have few legacy issues and have rapidly improved. iCloud has a few legacy issues related to traditional computer backup and iPhoto, as noted above, but because iCloud operates largely out of sight, it has also improved rapidly. Again speaking anecdotally, I now use iCloud Drive for all my folders/documents on both my Mac and iOS devices. 

The thing I like about Apple is that it's always trying to move users away from legacy approaches toward newer, more efficient ways of doing things. So Apple has abandoned built-in computer disk drives, is encouraging people to backup with iCloud instead of their computers, and is encouraging people to use Apple Music instead of continuing to download music through iTunes. Apple is trying to take care of legacy users who don't want to change while also "getting its foot in the door" by adopting new technologies that improve legacy services like iTunes and iPhoto (with services like Apple Music streaming and iCloud).

Companies that let legacy products and services rule their portfolio -- and don't get their foot in the door by adopting technologies that can improve products and services -- can pay a heavy price. Intel's adherence to legacy x86 chips, and its reluctance to shift to ARM chip designs, is a good example of this.

The author owns stock shares of Apple.

Functional Needs and Irrational Wants

The iPhone is like a pocket Porsche -- it comes in iconic, arguably artistic designs like a Porsche. The difference is that it's affordable to a lot more people. Artistic, iconic design leads to strong brand value and purchase decisions driven not just driven by rational, functional needs but also by irrational wants (desire, lust, envy, communicating status, etc.). Some consumer products have an inherent artistic element that goes beyond purely functional needs: cars, smartphones, fashion, furniture, and so on. Conversely, some consumer products are almost entirely functional in nature -- people buy or use them because of functional needs, not because of irrational wants. Some examples of purely functional products/services might be: hard drives (Christensen's famous example from The Innovator's Dilemma), backhoes, commodities like steel or glass, Internet search engines, and artificial intelligence. 

If you're selling a purely functional product, Christensen's "good enough" concept is particularly important. That's because irrational wants don't come into play, and the buyer can easily determine what's good enough by comparing the product's functional, measurable performance attributes with the particular job the buyer needs to get done. So a buyer can look at a hard drive, for example, examine its data retrieval rate and storage capacity, and compare that to his functional needs -- how he'll be using the computer and how many photos, videos, and documents he needs to store -- to determine whether the hard drive is good enough or whether it overserves.

As noted in other posts, the best way to keep functional product elements from overserving is to make sure improvements are meaningful and actually used by buyers.

Another great way to prevent functional overserving is through technological leaps that change consumer expectations of what's good enough. This happens when a company comes up with a breakthrough product that makes consumers think that existing alternatives -- that consumers previously felt were good enough -- aren't good enough anymore. The consumer's perception of what's good enough isn't static: it's relative and changing depending on the latest breakthroughs and what's available in the marketplace.

If a sustaining technological leap or breakthrough creates a large enough performance gap between the breakthrough product and existing incumbent alternatives, it may allow the entrant to establish the beachhead needed to effectively enter an existing market. An entrant with a sustaining improvement/innovation normally doesn't do well because incumbents respond vigorously. The exception may be an entrant with a surprise breakthrough product that catches incumbents off-guard -- you could argue the original iPhone succeeded this way.

Two challenges for an entrant with a breakthrough product may be: (1) the lack of a recognized, trusted brand; and (2) ramping up manufacturing, distribution, and marketing fast enough to take full advantage of the sales opportunity. Incumbents are highly motivated to "fast follow" the entrant's breakthrough product with similar products. The key question here is whether incumbents can quickly acquire the capabilities needed to compete with the breakthrough. In the original iPhone's case, Blackberry and Nokia were unable to fast follow the iPhone with similar products because they lacked Apple's integrated hardware and software capabilities. As a result Apple had the time needed to ramp up iPhone production and distribution. Apple's strong brand also helped.

Returning to this post's original subject, a person buying a Porsche or an iPhone -- or any other product with an inherent artistic element -- considers (1) functional needs but is also influenced by (2) irrational wants like the desire/lust for something beautiful. The good enough standard is highly relevant to the functional needs part, but may not be very relevant to the irrational wants part. And irrational wants become even more of a factor when the product is distinguished by iconic, artistic design. So a product with an artistic element may overserve a buyer's functional needs but still be something the buyer wants to purchase because of irrational wants -- a Porsche or a Ferrari is a good example of this.  

You could almost look at a product on a sliding scale: as a product's artistic/iconic elements go up, the relevance of what's good enough -- and the danger of overserving -- go down. The ideal situation may be a product with improving artistic elements and improving functional elements: the key here is that functional elements must improve in a meaningful way that's valued by consumers (to prevent unused, overserving features that actually end up degrading functional performance and ease of use).

Applying another Christensen concept, when the buyer's "job-to-be-done" encompasses purely functional needs, overserving is a greater risk. When the buyer's job-to-be-done is broad, encompassing both functional needs and irrational wants, there's less danger of overserving. 

Art vs. Algorithms

Industrial design sometimes rises to the level of art, and art doesn't commoditize. Artistic design creates tremendous brand value and is very hard to copy, and close copies are never valued as highly as the original. Examples of companies producing iconic products and industrial art include Braun, Ferrari, Porsche, Apple, and Tesla. Industrial art has driven the brand value of each of these companies. 

Conversely, algorithms and machine learning methods can be copied, and the copy is valued just as highly as the original because the product's appeal is based purely on functional needs. Much of the theory behind algorithms comes from educational institutions and is in the public domain. As noted above, Christensen's good enough concept -- and the danger of overserving -- is much more relevant with purely functional products.

So if you're an investor, it seems to make sense to invest in companies that make products that aren't purely functional. The ideal situation may be a company that makes a product with artistic elements, and that is committed to iconic design. This kind of business model is (1) hard for competitors to copy and (2) reduces the danger of creating an overserving product (since buyers in this kind of market are driven by both functional needs and irrational wants).

This post has been amended since it was first written. 

The author owns stock shares of Apple.

Moving Downmarket Without Damaging Your Brand

With the iPhone SE Apple is differentiating its products through size while still offering a best-in-class product at every price level. By differentiating through size, Apple can move downmarket with a less expensive iPhone without damaging its brand, and without detracting from an important motivator for people purchasing an iPhone: the status that comes from owning a best-in-class product (best four inch phone, best large phone, etc.). This was one problem with the iPhone 5c -- it was a downmarket move but it wasn't a best-in-class product. As a result the iPhone 5c degraded Apple's brand and failed to accomplish the job-to-be-done of communicating status.

The author owns stock shares of Apple. 

Country by Country

All Apple can do is make the best product possible within the legal constraints of each country it sells in. If it wants to sell iPhones in the United States, it has to comply with United States law. It it wants to sell in China or India or France, it has to comply with the laws in those countries. 

The courts or legislators in a particular country may make bad decisions about what the laws should be. At that point Apple will have to: (1) modify products sold in that country or (2) stop selling in that country. The first choice is an option as long as country-specific product changes don't jeopardize the quality and security of products sold in other countries. Apple may be forced to stop selling products in countries with laws that jeopardize the security of Apple products sold in other markets.

Apple's competitors will have to deal with these same issues. Some will mount vigorous defenses to bad laws, some will not, but the competitive playing field should be the same on a country by country basis. I think the main thing is for Apple to take firm, ethical stands against legal and governmental overreaching, protecting the user's security and privacy as much as possible. Companies that don't do everything they can to protect user security/privacy will suffer big hits to their reputation and their ability to attract and retain customers.

The author owns stock shares of Apple. 

The Benefits of Technological Improvement

Technological improvements to device security have made it harder for law enforcement to gather evidence. But technological improvements -- over the larger scope of human history -- have generally improved the human condition.

In How to Fly a Horse by Kevin Ashton, Ashton comments on how weaver-Luddites destroyed automated weaving looms because they feared losing their jobs. These looms eventually led, however, to greater manufacturing efficiencies and even more advanced technologies, which led to more jobs and more educated workers. More people learned to read and obtained higher levels of education, with huge improvements in living standards. Id. This trend has continued -- in multiple industries -- through the present day.

Ashton notes that no one could have predicted or anticipated the positive long term impacts of automated looms -- it is impossible to predict all the consequences flowing from a technological improvement. Id. Ashton says that new technologies always bring new problems, but that the answer is not to restrain the new, beneficial technology but to welcome unanticipated consequences, both good and bad, inventing and problem solving along the way. Id.

Apple and other device makers have been improving their products by making them more secure. These technological improvements will produce unpredictable long term consequences. As with past technological improvements -- like the automated loom -- many of these consequences will be beneficial and improve the human condition. Unforeseeable but largely positive long term consequences shouldn't be addressed through a wide-ranging, premature, regressive legal/government mandate that retards improvement and forces device makers to damage their own software/security (destroying their own "loom").

And law enforcement has the resources/expertise needed to address the evidence problem internally -- through their own decryption efforts -- instead of trying to roll back improvements to device security through the careful selection of "bad fact" cases that create bad law and destructive legal precedent. The FBI's internal decryption efforts might not be as easy or convenient, but a trade-off in convenience seems reasonable given the unanticipated, long term societal benefits of improvements in device security.

The author owns stock shares of Apple.

Growing Users Without Growing Profits

A number of popular companies with great products or services don't seem to make much money or are losing money; some of these are closely held, making it hard to determine the extent of losses. These companies include: Uber, Tesla, Amazon, Twitter, and Evernote.

I use Uber, Twitter, and Evernote regularly -- they're invaluable to me. Yet these companies apparently lack the pricing power needed to acquire users, grow sales, and generate/grow profits.

Investors satisfied with profitless sales growth seem to be banking on speculative, undemonstrated pricing power. Many investors believe these companies can turn a profit -- and generate healthy sales and sales growth -- once they stop focusing on the "land grab" effort of acquiring new users. When this kind of speculation doesn't pan out -- either user growth slows and/or profits never materialize -- the stock can really take a beating (a la Twitter). 

Absent aggressive, successful equity fundraising, a company that grows users without growing profits is going to have a hard time investing in its business and improving its product. Uber and Tesla have been very successful fundraisers, allowing them to continue releasing new, improved products/services. At some point though, investors want profits -- they want a return on their investment. Aggressive fundraising won't work forever. If the fundraising music stops and the profits aren't there, an unprofitable company faces major problems like paying its bills and improving its product/service at a rate sufficient to compete. Companies with profitable business models can invest in product/service improvements that unprofitable companies cannot.

If a stand-alone service can't increase its user base without losing money, what alternative business model could work? How could the service still drive profits? Possibly through tight integration with a product that does make money, like an iPhone or iPad or Apple Watch. Tight hardware/service integration creates a more unique, "magical" user experience by making things faster, simpler, and more convenient. As Michael Porter notes, companies should compete to be unique rather than competing to be the best.

It's worth noting that Apple doesn't try to compete within traditional, well-defined hardware or service categories -- they compete by trying to provide the best integrated hardware/software/service experience. This point was recently emphasized in John Gruber's podcast interview of Craig Federighi and Eddy Cue (on Gruber's "The Talk Show" podcast). When questioned about whether the quality of Apple's services was slipping, Federighi and Cue both emphasized that Apple focuses on the integrated, holistic user experience, not on the specific hardware or service component (consistent with Apple's functional organizational structure, its single P&L, and Steve Jobs's advice to focus on the user experience and work backward to the technology).

Apple's in a great position to cherry pick useful services and integrate them into their products, making their products more unique and "sticky." Apple can see how Evernote has become more and more valuable and can use this knowledge to make a more attractive, useful version of Notes. Apple can look at Uber's unprofitable transportation service and find ways to provide a more unique, magical user experience through an integrated hardware/service offering driven by profitable device sales (i.e., iPhone, Apple Watch, and Apple car). Apple can use the unprofitable stand-alone service to complement/strengthen its ecosystem and its profitable hardware.

This article has been amended since it was first posted. 

The author owns stock shares of Apple.

Thinking in Reverse

Google recently removed an ad blocker called Adblock Fast from the Google Play store. This product was designed to work with Samsung's mobile Internet browser, which operates on Samsung Android phones.

Apple permits ad blocking on iOS. Apple has also publicly announced its commitment to user privacy, stressing its efforts to keep user data on the iPhone rather than gathering this data in an Apple cloud database. Some worry that Apple's machine learning and AI efforts could suffer, since data can be better analyzed in the cloud than on the device itself. 

Google's recent ad blocking decision reveals the benefits of "thinking in reverse." Rather than looking at how Apple could be hurt by forgoing user data and permitting ad blocking, think about how Google could be hurt by an advertising business model that forces it to: (1) gather and deeply analyze user data; and (2) serve up ads that users can't block. Google's model may facilitate machine learning and AI while creating a permanent competitive disadvantage when it comes to ads.

The author owns stock shares of Apple.

Landlines vs. Cellphones, Traditional Watches vs. Smartwatches

For many years the general population thought telephone landlines were "good enough." When cellphones first came along, I remember thinking they were too expensive and unnecessary. Cellphones then got smaller and cheaper, while reception and functionality also improved. Now cellphones and more specifically smartphones are much better than landlines -- almost no solicitation, the ability to block calls, reliable coverage, and a computer that fits in your pocket. 

So the landline telephone, which people thought was good enough and didn't think much about, has slowly become not good enough, at least relative to current cellphone/smartphone options. That's because what's considered good enough doesn't exist in a vacuum -- buyers decide what's good enough based on available options. A product that's widely considered good enough today may not be considered good enough five to 10 years from now.

You can imagine the same scenario unfolding with traditional watches versus smartwatches. Today many people believe the traditional watch is good enough, and they consider smartwatches expensive and unnecessary. In five to 10 years though, smartwatch functionality will be far ahead of where it is now. At that point the traditional watch may not be good enough based on other available options like smartwatches. It's not hard to imagine a slow and immense market shift from traditional watches to smartwatches.

I think this analysis may also apply to traditional cable, advertising, and privacy/security. Maybe today traditional cable is good enough. But what happens as a la carte, on demand streaming options continue to proliferate? On demand streaming is going to change the consumer's perception of good enough choice/price. Customers may start walking away from cable providers that won't unbundle their content and price the unbundled components attractively. 

With advertising and intrusions to privacy/security, most people accept some of both so they can receive free services -- for them, privacy and security is currently good enough. But this could change as interconnected devices proliferate and privacy/security becomes more important -- people could start paying more for products designed to protect their privacy/security.

The author owns stock shares of Apple. 

Control Groups and Meaningful Improvements

I just finished reading Superforecasters by Philip E. Tetlock and Dan Gardner (Crown Publishers, 2015). In the book the authors talk about how the accuracy of most forecasts is never measured. Forecasters make predictions (often too vague to be verified or refuted), and no one later gathers data to determine who's right and what forecasting methods work best. So there's no feedback loop to improve forecasting accuracy. Id.

Tetlock and Gardner make an analogy to medicine. For many years doctors relied mostly on personal experience and intuitive judgment to decide what treatments to use. Over this time treatment outcomes either didn't improve or improved slowly. Then control groups were introduced, with one set of patients receiving a placebo and one set of patients receiving the new treatment. This allowed researchers to carefully measure treatment outcomes to determine what worked, what didn't, and how treatments could be improved. This feedback loop led to rapid improvement in medical treatments and outcomes. Id.

A company making smartphones could apply these same concepts to make more meaningful product improvements. So Apple could look at iPhone usage, and the value of its latest improvements, by providing 1000 of its employees with an iPhone 6s (the control group) and 1000 of its employees with a prototype of Apple's upcoming smartphone release (the test group). It could then measure usage of both phones, including various phone features, to determine whether the latest improvements are meaningful/used or whether they're overserving/unused. Feedback from these in-house controlled studies could help keep Apple from releasing overserving products.

Because Apple is so vertically integrated, it already is well-positioned to collect usage feedback from customers. This feedback makes it easier for Apple to identify meaningful product improvements while paring back features that aren't used or are overserving. This may be one of Apple's biggest competitive advantages in designing/creating new products and improving existing products: the customer feedback loop that comes from making the "whole widget."

OEM's that rely on the Android OS, or Android software engineers who must rely on OEM's, don't make the whole widget and therefore don't get end user feedback about the entire product. And when Google and Android OEM's do get meaningful end user feedback, their ability to act on it is limited by the fact that Google must design/improve Android not just for end users, but for advertisers that pay Google to collect user data and target these users with ads. Android is designed/improved based on end user feedback and advertiser feedback.

The author owns stock shares of Apple.

Integration and Iteration

When you look at how Apple is taking smartphone customers from Android vendors, it's striking how much product/service integration has helped. Apple's integration allows it to make a continuing series of cutting edge, meaningful product improvements, while its scale allows it to offer a competitively priced -- if still high end -- product.

Android vendors relying on undifferentiated, modular/standardized product elements -- like the Android OS or Qualcomm chips -- cannot seem to match the iterative improvement of Apple's products. These vendors are at the mercy of their modular suppliers, and these suppliers aren't keeping up with Apple: Qualcomm is having difficulty matching Apple's in-house chip design, while Google is having difficulty keeping Android updated and malware free. As a result Android vendors are forced to sell an inferior, commoditized product at an unprofitable price. Companies that do this long enough go out of business -- they run out of time and money to improve margins by moving up the product improvement trajectory. See Concepts page and discussion of Clayton Christensen.

You might expect a large group of modular suppliers to eventually catch up with Apple's in-house efforts, but it doesn't seem to be happening. If anything, Apple's profitability is making its in-house efforts even harder for modular suppliers to match, since Apple has the deep pockets needed to hire the very best talent.

The author owns stock shares of Apple. 

Fragile Ideas and Prototypes

There was an interview of Jony Ive not long ago in which he talked about Apple's product design process. He said this process starts with one or two people having an abstract idea; this first step usually doesn't involve much collaboration. The abstract idea then gets turned into a physical prototype. Collaboration really takes off as the prototype is made and refined.

Ive has repeatedly noted the fragility of new ideas. You don't want team members to just say "no" to ideas -- "what if we did this?" is generally better than "no."

I used to work as a trial attorney, and have seen the tactical benefits of getting jurors to take an early fixed position. A person who takes an early yes/no position is normally reluctant to change his mind later -- no one wants to admit his initial judgment was wrong. That's why opening statements at trial are so important: my goal with opening statement was to get jurors "rooting for" my side of the case early, and to keep jurors on my side as long as possible. I sequenced trial testimony to delay the presentation of evidence that hurt my case but had to be addressed, knowing that the sooner jurors started rooting for me, and the longer they rooted for me, the less likely they'd change positions when I had to address case weaknesses.

So the key is to keep people from spiking new ideas too quickly -- get people saying "what if we did this?" or "what if we changed this?" instead of taking a fixed "no" position that will be difficult to change later. 

I also thought it was striking how Jony Ive emphasized that collaboration worked best in conjunction with a prototype. So with product development, there may be significant collaborative benefits to turning abstract ideas into physical objects. Prototypes foster collaboration by giving team members a clear focal point and something to rally around. It's also hard to say "no" to the creation and improvement of a prototype -- team members are almost forced to constructively solve problems the prototype presents.

The author owns stock shares of Apple. 

Sustaining Innovations Based on Different Capabilities

Clayton Christensen recently described Uber as a sustaining innovation -- rather than a new market or low end disruption -- since its service is generally better than existing taxicab options. "One More Time: What is Disruptive Innovation?", by Clayton M. Christensen, Michael Raynor, and Rory McDonald (Harvard Business Review, December, 2015). In his books Christensen counsels entrants to avoid competing with incumbents through a sustaining innovation. See Concepts page and discussion of Clayton Christensen. That's because incumbents will aggressively respond to companies that try to enter their markets with a better product. You can currently see this happening in the auto industry, with incumbent luxury car companies offering more electric vehicles to compete with entrants like Tesla.

Christensen believes Uber is an "outlier," and that its success may be due to the regulated nature of the taxi industry. "One More Time," by Clayton Christensen, et al. These regulations make it difficult for incumbent taxi companies to compete with Uber. This seems logical. I think, however, that the biggest problem facing traditional taxi companies is that they lack Uber's (1) resources (infrastructure, employees, capital access, etc.), (2) processes (manufacturing processes, logistical processes, software development processes, etc.), and (3) values (margin goals, priorities/culture, etc.), which together make up a company's capabilities.

Christensen discusses resources, processes, and values ("RPV") in The Innovator's Solution. In this book Christensen says entrants with a sustaining innovation usually lose to incumbents because incumbents have the RPV -- the capabilities -- needed to match the entrant's improvement. The Innovator’s Solution, by Clayton Christensen and Michael Raynor (Harvard Business School Publishing Corporation, 2003). He also says that incumbents normally lack the RPV needed to match a product or service that's a new market or low end disruption. Id. 

Looking at examples like the taxi industry -- and contrary to what Christensen theorizes -- incumbents may not always have the RPV/capabilities needed to match an entrant's sustaining innovation. Regional taxi companies lack the equity capital resources and the refined logistical and software processes needed to effectively compete with a global company like Uber. Uber offers a better service based on fundamentally different capabilities that are constantly refined on a massive scale. These different capabilities -- and their steady improvement -- allow Uber to effectively challenge incumbents despite the sustaining nature of Uber's service. The lesson here is that Christensen's RPV framework is relevant in both a disruption context and a sustaining innovation context.

So an entrant with a sustaining innovation can effectively compete with incumbents when the sustaining, better product/service is based on RPV/capabilities that are non-traditional relative to the pertinent industry. In this situation incumbents will be hamstrung by capabilities tailored around traditional/existing industry offerings, whether it's (1) a taxi company with employee-drivers and a cab fleet (competing with Uber's logistics/software and thousands of independent contractors driving their own cars) or (2) a hotel company with service-related employees and hotel-related infrastructure (competing with Airbnb's logistics/software and thousands of owners renting out their homes). In both these examples you have entrants -- Uber and Airbnb -- offering a different/better service and competing directly against incumbents for existing industry customers (what Christensen calls competing against consumption). Christensen would predict failure because of a vigorous and effective incumbent response, yet both Uber and Airbnb are succeeding because their RPV/capabilities are different from those of incumbents, making it difficult for incumbents to respond.

Applying these ideas to Apple, the original iPhone could be viewed as either a new market disruption (a personal computer for a new context/situation -- your hand or pocket) or a sustaining innovation relative to competing cell phone products from Nokia and Blackberry. See post titled The iPhone Conundrum and New Market Disruption. Regardless of how you class the original iPhone, it was built based on software and hardware capabilities that Nokia and Blackberry seemed to lack, which allowed it to gain a market foothold without a meaningful incumbent response.

One other point: a company that sells a mediocre service/product -- particularly a product that's become a monopoly either through market dominance and network effects or through regulatory protection -- leaves itself open to not only new market and low end disruption, but also sustaining innovations based on different capabilities. An uncompetitive industry environment leads to complacency and deteriorating products and services. 

This article has been amended since it was first posted.

The author owns stock shares of Apple.