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.

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.

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. 

The MIT Critique of Disruption Theory

I just read Andrew King and Baljir Baatartogtokh's article in the MIT Sloan Management Review (Fall, 2015) titled "How Useful is the Theory of Disruptive Innovation?" The article is a critique of Clayton Christensen's disruption theory. I thought it made a number of interesting points, including the following (with my personal comments in boldface): 

  • Based on the authors' research, incumbents often lack the capabilities needed to respond to a new entrant's product/service -- when they have the capabilities they frequently do respond. 
  • Some incumbent products/services (local meatpacking) don't show any meaningful sustaining improvement over time, so there's no opportunity for overserving. In this situation you have the opposite of overserving: the product doesn't improve at all, or doesn't improve fast enough to keep up with user needs (a perennially underserving product/service). This kind of mediocre/poor product then gets replaced by something better. The entrant's better product is often based on capabilities that the incumbent making the mediocre/poor product lacks, making it impossible for the incumbent to respond.
  • Based on the authors' research, 78% of Clayton Christensen's examples from The Innovator's Dilemma and The Innovator's Solution don't involve overserving. If accurate, this would mean the concept of low end disruption for overserved users is inapplicable to these examples. 
  • I think it's important to note that overserving isn't as relevant with new market disruption. A new market product creates an entirely new market of consumers because the entrant emphasizes different product performance attributes than those emphasized by incumbents (the vertical "P" axis). These different performance attributes either: (1) make the product affordable to people who couldn't afford prior alternatives; or (2) allow the product to be used in a new, non-traditional situation/context, creating a new market of consumers for that new context (desktop computer as mainframe for your desk, smartphone as computer for your pocket). See Concepts page and discussion of Clayton Christensen.
    • In emphasizing different performance attributes, the new market entrant creates a non-traditional "value network" with a distinctive cost structure, different suppliers, different operating processes, and different sales channels. This value network is crafted around sales to non-traditional, new market consumers.
    • Incumbents typically lack the resources, processes, and priorities -- or what you could call the desire and capabilities -- needed to transition to the new entrant's non-traditional value network. This leaves incumbents stuck in the value network they've crafted for their traditional customers, unable to compete with the entrant for non-traditional, new market consumers.
    • If the new market entrant improves its product it can eventually sell not just to new market consumers, but to the incumbents' traditional customers, taking more and more business from incumbents.
    • The point of all this is that new market disruption can occur regardless of whether incumbents are overserving their traditional customers. An incumbent could be selling widgets that don't overserve its traditional customers (e.g., corporate customers that need powerful mainframes or minicomputers) and still have an entrant launch a product that emphasizes different performance attributes and creates a new market/class of buyers (e.g., individual consumers who need desktop computers). Incumbents with a traditional value network -- and resources, processes, and priorities tailored around this network -- would have difficulty competing in this new market. The entrant could then improve its product and eventually steal traditional customers from the incumbent, even though the incumbent's widget wasn't overserving traditional customers when the entrant came into the market.
    • The big challenge for entrants trying to create a new market of consumers is creating a profitable new value network that can survive over the long term. A new market entrant needs early profits to continue improving and integrating its product around the job-to-be-done, ideally through a unique, trade-off based strategy. Otherwise the entrant ends up engaged in price-based competition with late-arriving competitors selling the same basic offering.
      • Cut-throat price competition has played out in both the Windows PC market and the Android smartphone market. Apple has survived and prospered because the new market products it introduced, the Apple II, Mac, and iPhone, improved and became more integrated/differentiated over time (largely through Apple's ecosystem approach). See Concepts page and discussion of Clayton Christensen and Michael Porter.
  • Advances and sustaining improvements in technology sometimes produce outcomes which are the opposite of those produced by overserving -- they can make the product simpler and easier to use and more accessible to less savvy consumers. They can also make the product more affordable to low end users.  
  • The authors counsel using disruption theory not for prediction, but as a warning to avoid overserving (which is typically caused by a series of meaningless sustaining improvements unconnected to the underlying job-to-be-done).

The boldfaced language discussing new market disruption has been amended since this article was first posted.

The author owns stock shares of Apple.

Ability to Partner as Competitive Advantage

When it comes to services, Apple is in a better position to partner than any other tech company. It's difficult for Facebook or Google to closely partner with other service providers because other providers steal user attention and hurt ad sales. Horizontal service companies trying to be on all devices depend on the user's choice of their services over other services. 

A vertically integrated player like Apple doesn't care if its services dominate. Apple wants its services to be attractive and promote ecosystem stickiness, but Apple doesn't need its services to dominate to drive profits. That's because Apple's profitability is driven not by services, but by a three part mix of hardware, OS, and ecosystem. No single element of this mix dominates, and Apple can have a great ecosystem with in-house services/apps like contacts, calendar, notes, maps, and iWork, and third party services/apps provided by IBM, Microsoft, Twitter, Google, Facebook, and thousands of independent developers.

If you don't need your services to dominate or even be profitable to prosper, then you're free to partner with any service company you want. And that's what Apple does, partnering with IBM for enterprise software, Microsoft for its Office suite, and even Google for maps. These kinds of partnerships are difficult if you have a horizontal business model and you need your services to dominate to drive subscriptions or ad sales (e.g., Google search, Facebook, Evernote, etc.).

In a 2007, D5 interview Steve Jobs said he admired Microsoft's ability to partner with other companies. Apple now seems to address this issue by partnering as convenient on services while still owning the key hardware, manufacturing, and OS technologies and IP. See post titled Why Apple "Outsources" Applications and Services.

The author owns stock shares of Apple.

Good Intentions + Secure Systems/Processes = Trust = Access

I have a short theory on what promotes access to user data. If a data collector has good intentions in that it appears focused on helping me rather than third parties, and this is reflected by secure systems and processes, then I'm more likely to trust it and give it access to my data.

Conversely, if a data collector has bad intentions in that it appears focused on helping third parties as much as helping me, and this is reflected by less secure systems and processes, then I'm less likely to trust it and give it access to my data.

I believe this phenomenon may be playing out with Apple and Google/Android. Many Android users are currently giving Google tremendous access to their data, but as they're tracked and bombarded with ads, and they become more aware that Google is focused on serving both end users and third party advertisers, they may become less willing to give Google access. This trust problem is magnified by Android fragmentation and the difficulty of keeping Android secure.  

As users become more sophisticated/educated about the use of their personal data, it seems likely that good intentions (prioritizing end users instead of third parties) and secure systems/processes will be needed to create the trust needed for smartphone makers to continue collecting user data. 

Companies that create user trust are in the best position, over the long term, to collect the most relevant, valuable user data. Because trusted companies are in a better position to gather relevant user data, they may also end up with better intelligent services (whether it's Siri or Google Now).

One other point: it's been argued that people will give up some measure of privacy/security regarding their personal data in order to obtain better intelligent services (like Google Now). I'm not convinced of this -- to me this is like arguing that I'll trade away the security of a bank account for the greater convenience of hiding cash under my mattress. And why would I trade away privacy/security if there's a smartphone maker I trust that can protect my data while still giving me more than "good enough" intelligent services (a la Apple)? I know I sound too much like an Apple fan.

The author owns stock shares of Apple.

Apple News, Ad Blockers, and Asymmetric Models

Apple is getting ready to release iOS 9, which will include the Apple News app as well as the ability to block many browser-based ads. Publishers using Apple News will be able to keep 100% of any ad sales they generate themselves and 70% of any ad sales generated through iAd.

Taken together, Apple News and ad blocking seem focused on improving the user experience. In Jobsian style, Apple is starting with its vision of the optimal user experience -- fewer ads, more security/privacy, and less demand on computer resources -- and working backwards to the most appropriate technology/approach. iOS 9 hasn't been released (in non-beta form), but it appears publishers will still be able to use native advertising in Apple News, and that native ads in published web content will survive most ad blocking. If true, it would mean Apple is taking advertising control away from the companies that aggregate user data and track/target users with advertisements (also known as programmatic advertising) and returning this control to content publishers and creators.

With Apple News and ad blocking, Apple is betting it can improve the user experience and thereby drive even more profitable hardware sales. Apple's business model doesn't rely on advertising profits -- it relies on hardware profits driven by a superior user experience.

Apple's model is asymmetric to Google's business model, which depends on user data and profits from targeted advertising. Because Google relies on advertising profits rather than hardware profits, it will be hard for Google to follow Apple's approach. For this reason ad blocking and Apple News could be unique, differentiating activities for Apple. As discussed previously, companies should compete to be unique rather than competing to be the best. See post titled Defaults, New Performance Attributes, and Competing to be Unique. 

If Apple News is widely adopted, it's also easy to imagine it supplanting a lot of web browsing. Apple users could end up getting most of their news from Apple News, reducing the need to browse. This hurts Google but not Apple.

For additional information readers should check out Charles Arthur's excellent article, "The adblocking revolution is months away (with iOS 9) -- with trouble for advertisers, publishers, and Google."

The author owns stock shares of Apple.

Defaults, New Performance Attributes, and Competing to be Unique

Using Defaults to Compete with Incumbents

I wanted to write a quick post on how Apple seems to use integrated device defaults, and the notion of defaults in general, to enter existing markets. Apple acquires Beats and then creates Apple Music and an accompanying streaming service to compete with incumbents like Spotify. Similarly, Apple develops and rolls out Apple Maps, makes it the integrated default, and effectively competes with incumbents like Google Maps (even though Apple Maps started out as an inferior service).

Clayton Christensen recommends entrants avoid entering existing markets to compete with incumbents because incumbents respond vigorously. When you're an integrated competitor controlling the service defaults on your devices, that advice may not apply. See Concepts page and discussion of Clayton Christensen.

Using New Performance Attributes to Compete with Incumbents

It seems like Apple is also using the concept of defaults to effectively enter the AI, search, and machine learning business. Apple is telling consumers that it's default approach with Siri, Spotlight Search, Proactive, and Intelligence is privacy first, data collection second. And Apple is contrasting its privacy/security priorities with the data first approach of Google and Facebook.

Apple is emphasizing a different default or performance attribute -- privacy/security -- to gain customers who value the privacy/security attribute more than the machine learning attribute. Apple is getting its foot in the AI, search, and machine learning business by prioritizing privacy/security and by not targeting users with ads (unlike competitors), offering consumers a private, ad-free environment that still provides high quality AI, search, and machine learning. Apple will improve its AI and machine learning capabilities over time, just as it's done with Apple Maps.

Using a new performance attribute (privacy/security) to enter an existing market (search, AI, and machine learning) is a form of new market disruption. See Concepts page and discussion of Clayton Christensen. And Apple's approach is asymmetric to what Google and Facebook can do because Google and Facebook must gather data and target ads to generate advertising profits. Apple generates all or most of its profits from hardware sales, not ads. So Apple is well-positioned to pursue a unique, differentiated approach to AI, search, and machine learning -- a more balanced approach that factors in privacy/security concerns. Ad-driven competitors are going to have difficulty matching this type of offering. 

Competing to be Unique

Michael Porter defines strategy as competing to be unique through a trade-off based set of unique activities with great fit. He also counsels companies to avoid benchmarking -- and competing to be "the best" at specific benchmark attributes -- because it leads to homogenous, undifferentiated products and price-based competition. See Concepts page and discussion of Michael Porter. 

Apple's approach seems consistent with Porter's notion of strategy: the company is forgoing some data collection to create a private, ad-free user experience, believing it can still create a high quality AI/search offering. Apple isn't competing to be the best at AI or search or machine learning. Apple is competing to offer a unique product/service -- based on an attractive combination of trade-offs -- that solves jobs-to-be-done for a meaningful segment of the populationSee post titled Acquisitions, Rivalry, and Strategic Trade-Offs.

Going a little further, Apple isn't selling the best AI, search, or machine learning -- it's selling a great, unique user experience with all the trade-offs that entails. Good trade-offs are the essence of good, tasteful product design, and Apple excels at design.

By pursuing a unique approach to privacy/security and AI/machine learning, Apple also reduces rivalry with Android OEM's. Apple and Android OEM's can sell differentiated, non-homogenous products, which helps avoid zero sum, price-based competition. Some will prefer Apple's approach and some will prefer Google's, and that's fine.

With complex products and services there is no one right way to solve a problem or address a job-to-be-done. Different consumers will prioritize different functions or features, meaning there's more than one way to make trade-offs and design a commercially successful product. This especially applies to large markets like the one for mobile devices and services. When the "market pie" is large, each pie slice is big enough for a viable, profitable business, meaning each industry player can design for its particular slice without engaging in a high rivalry, "speeds and feeds" spec battle. Apple has consistently followed this approach, refusing to engage in product/service benchmarking based on tech specs or specific product attributes.

Apple is also on the right side of a global trend -- both people and governments (especially in developed European countries) want user privacy/security factored into mobile devices and services. Apple seems to be skating to where the puck is going to be, betting that people and governments are going to want mobile devices to be private and secure, especially as these devices proliferate and are used for payments, unlocking doors, health records, identity verification, and so on. It reminds me of a quote from Franz Kafka that my father had on his office wall:

"In a fight between you and the world, bet on the world."

The author owns stock shares of Apple.

Competing Alternatives Define "Good Enough"

Just a short post based on a comment I recently made on Ben Thompson's excellent website, Consumers can't really assess whether something is "good enough" in a vacuum -- they need competing alternatives to make this assessment. As competing alternatives change and improve, it seems logical to assume that consumer expectations of what's good enough also change.

Competition also helps consumers assess the value of each company's improvements -- it allows consumers to compare products that do and don't have the new feature or functionality, which helps them decide whether the improvement is meaningful or overserving.

Extending these ideas, industry-wide innovation, often driven by intense rivalry, seems to change consumer expectations of what's good enough, raising the trajectory of the improvement absorption line. The absorption line reflects the consumer's ability to absorb sustaining product improvements. See Concepts page and discussion of Clayton Christensen. When the trajectory of this line shifts up, industry competitors have more runway to make sustaining improvements that don't overserve.

When you look at Apple and Google you can see how competition has benefitted both companies, pushing them to make meaningful product improvements that keep raising consumer expectations of what's good enough. Apple comes out with a new version of Photos, Google comes out with Google Photos and Now on Tap, and Apple comes out with improved Siri functionality and Apple's new "Intelligence" feature. These product improvements/iterations drive each company's future sales and profits.

In slow-changing industries with big time gaps between sustaining improvements, the good enough and overserving concepts seem more relevant. See Concepts page and discussion of Clayton Christensen. These ideas don't seem as relevant in industries like tech, where iterative improvement is continual and can persist over long time periods.

The author owns stock shares of Apple.

Prioritize Great Products

Marketing and even strategy are irrelevant without great product design and a great product. As noted in Becoming Steve Jobs, Apple was nearly bankrupted when Windows 95 was released and was better than the Macintosh OS -- a better competing product caused Macintosh sales to tank. Becoming Steve Jobs, by Brent Schlender and Rick Tetzeli (Random House, 2015). Pixar overcame early troubles through a great product -- "Toy Story" -- that led to a successful IPO. Id. NeXT succeeded because the company's great OS made it an attractive acquisition target (NeXT was acquired by Apple). Id. Conversely, NeXT struggled early on because it failed to create a great computer for its target market. Id. Google's success flows from a great search engine. Great products are core to a company's success.

Without a well-designed, well-engineered product, the best sales, marketing, and strategy have a muted or immaterial impact. You need a compelling product first. I think this is why Tim Cook is always emphasizing how Apple is focused on making "great products." Compelling products are the priority and drive a company's long term success or failure -- not marketing, sales, strategy, or financial measures of capital efficiency. A company that focuses too much on sales or marketing or capital efficiency has lost sight of what made it successful in the first place -- a compelling product.

So How Do You Make a Compelling Product?

Great products are designed around jobs-to-be-done. See Concepts page and discussion of Clayton Christensen. As noted in Horace Dediu's podcast with Bob Moesta, Critical Path #146, a company can think about jobs-to-be-done by looking at the functional, emotional, and social "energies" that surround a consumer's purchase decision. Functional energy refers to the physical effort expended in making the purchase. Emotional energy refers to any anxiety, fear, uncertainty, pleasure, security, or ease involved in the purchase. Social energy refers to concerns about what other people will think about the purchase.

In the podcast Dediu and Moesta also discuss the Kano Model of Quality, which says that products consist of the following attributes:

  1. Basic attributes: Attributes that must be present for the consumer to buy, like an affordable price, enough computer memory to store all the consumer's media, basic customer service, etc.
  2. Performance attributes: Measurable feeds and speeds like horsepower, engine size, zero to 60 acceleration time, battery life, number of pixels, etc.
  3. Excitement attributes: Subtle details that are often hard to quantify but that create delight or excitement, like the tactile qualities of sports car controls, the sound or smell of a car engine, the way a product is packaged, etc.

Looking at functional, emotional, and social energy, it's easy to see why the Google Glass hasn't sold well. It's expensive and has been difficult to try out, which raises the functional energy needed to purchase in addition to increasing negative emotional energies like buyer anxiety and uncertainty. And the social energy of the Google Glass seems tremendously negative -- potential buyers are obviously concerned about how people will react to someone who may be surreptitiously recording them.

With the Apple Watch, Apple's online and retail stores reduce the functional energy needed to make the purchase. Apple's retail stores reduce negative emotional energies like anxiety and uncertainty while increasing positive emotional energies like pleasure, security, comfort, and ease. Apple's brand strength conveys status, making the social energy of the Watch a positive. Excitement attributes -- subtle details -- also seem to work in favor of the Watch, whether it's product packaging or haptic feedback or clasps on the Watch bands.

In looking at products like the Google Glass and Apple Watch, the first order question is not whether the product is a logical part of a grand strategy, but whether the product itself is a great product. Is the Apple Watch a great product? Is Google Glass a great product? Is Google still coming up with innovative, great new products, or are its products more market/sales driven? Do recent European Commission filings -- regarding possible search engine bias in favor of Google sites -- suggest Google is too focused on sales and is losing its focus on a great search engine/product? Is Amazon coming up with great, innovative new products? Is the Fire Phone a great product? These are important questions in assessing a company's long term success or failure.

The Importance of People and Collaboration; Investing Issues 

Great products require lots of good ideas. These ideas come from teams of great people collaborating well together, not from just one person. With complex, cutting edge products, one person can't do it all. Hence the critical importance of: (1) hiring the best people; and (2) creating an environment that fosters candid, free-flowing communication/collaboration among these people. See post titled The Rational Management Checklist.

From an investing perspective, it's also worth noting that the typical retail investor probably can't assess whether an industrial/b2b product is "great" and well-targeted on a job-to-be-done. That's because a retail investor normally lacks hands-on experience or deep knowledge of b2b products. With b2b companies a retail investor has to rely more on portfolio diversification and financial ratios/metrics.

Conversely, retail investors can use and directly experience consumer products, allowing them to subjectively assess whether a company is making great products and/or whether a company's products are improving or deteriorating.

The author owns stock shares of Apple.

Device Size and Design Tradeoffs

As devices get smaller, more design and engineering tradeoffs are required. With a desktop PC, there's a large screen and it's easy to include expansive options and features without big tradeoffs. With a smartwatch there are lots of constraints: screen size, readability, weight, battery life, holding up one's arm for extended time periods, and so on. These constraints demand lots of tradeoffs. Apple excels at making design and engineering tradeoffs, meaning a smartwatch plays to the company's strengths. Apple specializes in: (1) simplifying products through careful design/curation; (2) making design and UI choices on behalf of users; and (3) filtering/managing the features and information provided to users. Algorithms and machine learning aren't as relevant here. Judgment, taste, and design prowess are required.

It will be interesting to see if smartwatch companies relying on a stock OS (Android) from a company (Google) that's focused on machine learning can effectively compete with the Apple Watch.

The author owns stock shares of Apple.

Riding Waves

I just listened to another excellent podcast from Asymco's Horace Dediu: Critical Path #145: "Arbitrage." Near the end of the podcast Dediu talks about how cord cutting and the demise of cable television is following a slow but predictable path. The downward trend in cable subscriptions may accelerate as over-the-top ("OTT") content distributors like Apple, Netflix, Google, and Amazon offer more and more unbundled alternatives to the current oversupply of bundled cable channels. Dediu's comments reminded me of how Steve Jobs compared taking advantage of technological change to picking and riding a giant wave:

"Things happen fairly slowly, you know. They do. These waves of technology, you can see them way before they happen, and you just have to choose wisely which ones you're going to surf. If you choose unwisely, then you can waste a lot of energy, but if you choose wisely it actually unfolds fairly slowly. It takes years."

The Cord Cutting Wave

You can really see Apple riding the cord cutting wave with Apple TV: years of overserving and price inflation in the cable TV business have created a huge wave for OTT providers. See post titled HBO, ESPN, and Jobs-to-be-DoneAnd Apple's closed ecosystem of hardware devices amplifies its ability to exploit this wave -- Apple will get more benefit from cord cutting hardware than companies without a closed ecosystem, since Apple TV will drive the sale of other Apple ecosystem products that work with the Apple TV (Apple Watch, iPhone, MacBook, etc.). OTT providers like Netflix, Google, and Amazon won't get these same benefits because they don't have a viable, prosperous range of closed ecosystem hardware all running a consistent operating system.

The Cloud Storage Wave

The other big wave Apple seems to be riding is the way people are moving their personal photos and videos (as well as all other content) from their computer hard drives to the cloud. With the release of Apple's latest Photos app, people are going to stop storing personal media on their hard drives and start storing it on iCloud. Because Apple's range of closed ecosystem devices makes the user experience the easiest and most convenient, Apple is going to be in a great position to charge for iCloud storage of this media (even if Google and Amazon are giving cloud storage away). iCloud storage of personal media is really going to lock customers into Apple's ecosystem, dramatically raising switching costs. This trend/wave is just starting, and Apple will be able to ride it indefinitely as data storage demands continue to rise.

The author owns stock shares of Apple.

Apple Watch Isn't Good Enough (that's Great News) and Overlooked Jobs

Christensen says products first become good enough on functionality and reliability and then become good enough on accessibility/convenience, ease of use, affordability, and customization. See Concepts page and discussion of Clayton Christensen. Unlike with many other tangible products, aesthetics and status communication assume core functional roles with jewelry and other luxury items like expensive cars, handbags, and clothes. For this reason any aesthetic/appearance problems with the Apple Watch amount to an important functional issue rather than something more superficial.

A lot of people are looking at the Watch and saying "it's not good enough" because of a range of issues related to functionality/reliability: battery life too short, watch too thick or clunky looking, too tethered to the iPhone, not enough health sensors, etc.

The irony is that these shortcomings should be good news for the Watch's future. That's because under disruption theory, when a product isn't good enough on a range of performance dimensions, then the vendor has lots of things to improve -- through new product versions -- before the product starts overserving. See Concepts page and discussion of Clayton Christensen. This means there's lots of room for Apple -- as an integrated manufacturer -- to making sustaining leaps ahead of more modular smartwatch competitors relying on Android. See post titled Apple's Long Term AdvantagesApple has plenty of room to improve the user experience and move up the improvement trajectory without overserving.

And Apple doesn't need huge Watch sales right up front. The large margins implicit in the Watch should allow Apple to generate early profits and then slowly grow sales and profits over time. This is consistent with Christensen's recommendation that companies pursuing new market disruption be impatient for profits and patient for sales growth. See post titled New Markets and Early Profits.

Overlooked Jobs-to-be-Done

The inherent filters provided by the Apple Watch (small screen, having to lift up arm, etc.) and the convenience of having your most important information on your wrist should help users:

  1. quickly/automatically funnel down to their most important information/tasks; and
  2. quickly/discreetly check their most important information in a polite, non-intrusive way.

These two benefits help the Watch accomplish two important, possibly overlooked jobs:

  1. helping users stay focused/productive and thereby saving them time (less time spent checking/rechecking an iPhone and going on iPhone app/browsing detours);
  2. improving human interaction by allowing users to discreetly/efficiently multitask without being rude to people they're interacting with.

The irony of the Watch is that it promotes less screen time and more human interaction, a worthwhile goal in a world of 24/7 technology.

The author owns stock shares of Apple.

"Quality is the Best Business Plan, Period" and the Low End Dilemma

The quote above comes from John Lasseter, the chief creative officer at Pixar. A similar quote comes from a Jony Ive interview on Apple's product design process: "If it's not very good we should just stop ...." I think these quotes capture why certain companies -- BMW, Mercedes, Porsche, Ferrari, Disney/Pixar, Apple, and so on -- survive and prosper over such a long time period. They consistently focus on delivering a well-designed, high quality product, which leads to a great user experience, a strong brand, and high customer loyalty. These companies all put superior product quality ahead of affordability, allowing them to survive and grow even with limited market share.

Low cost, low end products often lack the quality needed to deliver a great user experience, which leads to disloyal customers who will trade up for a high quality alternative as soon as they can afford it. A college student driving a Ford compact looks forward to the day when he can maybe afford a BMW sedan.

This may explain why Android OEM's are losing business to Apple. It may also explain why low end companies with low margins often seem to disappear, while a few luxury brands survive for decades. In the short run the low end may be appealing, especially from a market share perspective, but in the long run low end customers defect and support the survival of high quality vendors.

The Low End Dilemma

Companies with a low end, modular business model -- that are trying to disrupt incumbents making high quality products that are arguably more than good enough -- face another big challenge: making the meaningful product improvements needed to move upmarket. When a company with a low end disruptive model can't move upmarket, it ends up wallowing in the low end, engaged in unprofitable, price-based competition. See Concepts page and discussion of Clayton Christensen.

This seems like the problem currently faced by many low end Android OEM's. These OEM's are assembling modular components while trying to move upmarket to compete with companies like Apple. The problem is that it's hard to move upmarket -- with meaningful, well-designed product improvements -- with a low end business model premised on cheap, modular components. An integrated competitor focused on high quality rather than price -- like Apple -- is better positioned to make meaningful product improvements (e.g., Apple Pay and Apple's Touch ID) that distance itself from low end, modular assemblers that must rely on superficial improvements to product appearance, components, or features.

This may be why so many Android OEM "improvements" amount to unnecessary changes or features. These changes often add complexity rather than fundamentally improving a product's convenience or ease of use.

The business prospects of a modular low end player that falls too far behind an integrated company making fundamental improvements are not good.

The author owns stock shares of Apple.