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.

Growing Profits and Preserving Brand Value

A simpler, cheaper, or more convenient product that targets overserved low end consumers, or that creates a "new market" of new users or new use cases/contexts, isn't always successful, even if the product maker has an asymmetric business model that creates early profits. Early profits are necessary, but these profits must grow so the product can be improved at a rate sufficient to stay competitive. See Concepts page and discussion of Clayton Christensen. Otherwise the new product is never going to see wide adoption, especially if more profitable competitors, often with different business models, keep making meaningful improvements while holding price or moving downmarket. 

Apple moves downmarket -- while preserving its brand image/cache -- by reducing the price of older products that were formerly state-of-the-art. An older Apple product, just like a used Porsche, still communicates status because (1) it used to be state-of-the-art and (2) because an onlooker can't tell whether the product was bought used/old or new. 

With new products Apple holds prices fairly constant, waiting for low and mid end consumers to move upmarket rather than aggressively chasing these consumers downmarket. Apple waits for consumer purchase power to rise over time, skating to where the puck/money will be. At the same time Apple keeps trying to make meaningful improvements, and the occasional technological leap, to prevent overserving and to keep raising consumer expectations of what's "good enough." See Concepts page and discussion of Clayton Christensen.

It's interesting to compare how Apple and luxury car makers like BMW and Mercedes try to preserve brand value. Apple releases one state-of-the-art iPhone each year, and then reduces the price of this phone the next year. All of Apple's product releases are a big deal, with ample press coverage, because Apple has few products and few product releases. As a result lots of people know the name and appearance of the latest iPhone model, and they know it's at least arguably a best-in-class product. 

By contrast, BMW and Mercedes release dozens of car models every year, with many variations in trim, car size, engine size, price, and so on. Because of all these models the typical onlooker doesn't know the cost and functionality/performance of a BMW or Mercedes he sees on the street. BMW and Mercedes don't seem to consider any one model particularly special -- otherwise why release so many versions? They can't all be best-in-class, and if the typical onlooker can't discern which is best-in-class then why should he care about the brand or aspire to own the vehicle?

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.