Winner-Take-All and Communicating Your Strategy

There have been recent articles on how Apple currently has 92% of smartphone profits. There has also been discussion of steadily growing Mac sales despite a declining PC market.

These two developments reminded me of Michael Porter's "What is Strategy?" article, written for the Harvard Business Review in 1996. HBR's 10 Must Reads on Strategy, "What is Strategy?" by Michael Porter (Harvard Business School Publishing Corporation, 2011; article originally published in November, 1996). In the article Porter states the following:

"When activities complement one another, rivals will get little benefit from imitation unless they successfully match the whole system. Such situations tend to promote winner-take-all competition. The company that builds the best activity system . . . wins, while rivals with similar strategies . . . fall behind. Thus finding a new strategic position is often preferable to being the second or third imitator of an occupied position."

Id. Applying this quote, Apple has a unique "activity system" with great fit across activities. This seems to be driving rising sales and an ever-increasing share of PC and smartphone profits. See post titled Acquisitions, Rivalry, and Strategic Trade-Offs. 

And consistent with Porter's prediction, rivals with similar, Apple-like strategies are still being hurt by winner-take-all effects. Companies with forked versions of Android and integrated, well-designed hardware -- like Xiaomi in China -- are having difficulty following Apple's profitable path. Because it relies on forked Android, Xiaomi cannot quite match Apple's activity system and the fit across these activities. Porter might counsel Xiaomi to find "a new strategic position" rather than "being the second or third imitator of an occupied position." Id.

One other small point: Apple has always been open about its strategy of focusing on great products, following an integrated approach, and owning the key technologies. I've sometimes wondered whether it's good for Apple to announce its strategy this way. Michael Porter addresses the issue in an interview at the end of Understanding Michael Porter by Joan Magretta:

"If your competitor hears you give a speech about your strategy, so much the better. Because if you have a clear strategy with trade-offs and choices, the more the competitor knows you're committed to it, the more likely they are to do something else, to avoid head-to-head competition where they're not going to be able to win. 

. . .

[Y]ou don't necessarily want to tell your competitor which machine you're going to buy and when you're going to introduce a new product and all the details that might give them some ability to make things difficult for you. But the basic direction you're going is something else."

Understanding Michael Porter, by Joan Magretta (Harvard Business Review Press, 2012).

The author owns stock shares of Apple.

Xiaomi and Apple

Background

As an Apple investor I think a lot about Xiaomi and whether it's a threat to Apple. Xiaomi's smartphones run MIUI, a forked version of Android. Google Play and Google services are banned in China, at least in large part. So in China MIUI works with: (1) Xiaomi's own services, including contacts, calendar, SMS, notes, photo album, etc., very similar to Apple and Google services; and (2) Xiaomi's own app/content store called Mi Market. Xiaomi services include a cloud storage/syncing service called Mi Cloud. Outside China Xiaomi smartphones come with Google services and the Google Play store pre-installed, per the Android license agreement. So outside China MIUI works with Google services and the Google Play store. Google's absence inside China, its presence outside China, and the mandates of the Android license agreement have effectively forced Xiaomi to adopt two strategies: vertical integration and proprietary services inside China and a more horizontal/modular approach outside China.

Michael Porter calls a company that tries to implement more than one strategy a "straddler," and that's what Xiaomi appears to be. The problem with straddling is that it makes it more difficult to create a unique set of activities with trade-offs and good fit across activities. Xiaomi is trying to improve its proprietary services, and its vertical integration inside China, at the same time it's expanding internationally with a modular approach that requires it to pre-install Google services and Google Play per the Android license agreement (this agreement apparently requires Android OEM's to pre-install Google services in international markets where Google services are available, like India). See post titled Acquisitions, Rivalry, and Strategic Trade-Offs. As a result, Xiaomi must ensure MIUI integrates well with its own proprietary services (inside China) and with Google services and Google Play (outside China).

Analysis

Some of Xiaomi's Chinese products bear a close resemblance to Apple products. China has more relaxed IP laws. This makes vertical integration easier, at least in terms of Xiaomi's in-house design and manufacturing. This kind of imitation is more difficult outside China, where IP laws are more stringent. One question is whether Xiaomi can develop the design capabilities needed to create useful products that sell well outside China, while still complying with international IP laws.

A lot of Xiaomi's China success is based on: (1) low price; (2) design similarities between its products and Apple's; and (3) a unique, proprietary ecosystem similar to Apple's. These three strengths go away, or are weakened, when Xiaomi tries to sell products internationally. When competing internationally, Xiaomi loses at least part of its low price advantage because it has to pay IP licensing fees. IP laws also make it more difficult for Xiaomi to sell Apple-like designs. And international pre-installs of Google Play and Google services make it more difficult for Xiaomi to market/sell a unique, vertically integrated ecosystem similar to Apple's. Outside China Xiaomi looks a bit like Samsung -- an Android player that uses pre-installed Google services/content and is stuck in the mid to low end market. Undifferentiated competitors stuck in the middle typically get squeezed by high end, differentiated vendors and by low cost, undifferentiated vendors. See Concepts page and discussion of Michael Porter.

For now it looks like Xiaomi is going to sell (1) vertically integrated, Apple-like products in China and (2) modular products with standard Google services internationally. This gives Xiaomi two activity sets to manage, with one set based on no Google services and a closed, proprietary ecosystem and one set based on Google services and a more open ecosystem.

These two approaches don't really complement each other, and they're driven by different priorities. In China, where Google services aren't pre-installed, Xiaomi can freely pursue vertical integration, focusing on improving its ecosystem and moving upmarket to compete with Apple. Xiaomi recently introduced some fairly expensive smartphones for the Chinese market.

Outside China Xiaomi won't be able to pursue a unique, closed ecosystem -- it will have to pre-install Google services per the Android license agreement. To the extent this agreement allows Xiaomi to install its own services, Xiaomi will have to compete with Google Play, slowing international consumer adoption of Xiaomi services.

For these reasons Xiaomi's outside China strategy/activities will have to focus on something other than differentiation through unique, vertically integrated products. The company may have to move downmarket internationally, driving down costs so it can sell mid to low end smartphones in places like India and Brazil. This puts Xiaomi in a strategic "straddle," trying to: (1) move upmarket with mid to high end products and a differentiated strategy in China (while ignoring international IP laws); and (2) move downmarket with low cost products and an undifferentiated strategy elsewhere (while following international IP laws). This seems like a tough challenge.

Xiaomi must also make MIUI function well inside and outside of China while avoiding any conflicts or customer confusion arising from Xiaomi's proprietary services and Google's pre-installed services.

China and non-China strategies could lead to one of two outcomes: (1) one or more Xiaomi products that attempt to satisfy both strategies -- something that's differentiated for China, like a typical mid to high end product, but still international IP compliant and low cost to make, and can therefore be sold in places like India and Brazil; or (2) two Xiaomi product lines, with one line focused on mid to high end differentiation in China and one line focused on low cost, international affordability. This second approach could lead to a very broad product line, making great product design more difficult.

Inconsistent strategies and/or too many products can make it hard to compete with focused competitors that have one uncompromised strategy centered around a limited number of products, clear priorities, unique activities, and great activity fit (e.g., Apple).

It's difficult to predict the future. It will be interesting to see how Xiaomi does.

The author owns stock shares of Apple.

Why Apple Can Target the Mid-Market

Apple's proprietary OS and iOS give it sustained product differentiation, as noted by Ben Thompson at stratechery.com. It's very difficult if not impossible to copy an operating system due to its complexity (despite other companies, like Samsung and Xiaomi, copying Apple's UI style). Michael Porter's four generic strategies are: differentiated and targeting a broad market; differentiated and targeting a niche market; low cost and targeting a broad market; and low cost and targeting a niche market. See Concepts page and discussion of Michael Porter.

Competitors typically don't want to get stuck in the middle, selling an undifferentiated product that's not low cost to the middle of the market. That's because they lose business to: (1) low cost, undifferentiated competitors who can beat them on price; and (2) high end, differentiated competitors who can beat them on quality, service, and product features.

But what Apple seems to do is take the high end market and then take the mid-market. And it can comfortably do this because it has sustained differentiation through OS and iOS. This differentiation means that low cost competitors can't compete with Apple based solely on price. So Apple can put a mid-market ceiling on low cost competitors by dropping price, selling both mid-market and high end products (and letting low cost, low margin competitors put each other out of business through price-based competition).

And Apple is already at the differentiated high end, so other high end competitors are a de minimis threat if Apple also decides to offer differentiated, mid-market products.

The author owns stock shares of Apple.

Why Apple "Outsources" Applications and Services

I believe Apple's business model is based on hardware profits, rather than profits from apps and services, because expensive hardware creation and the accompanying creation of Apple's OS and iOS are uniquely suited to the resources and capabilities of a large, well-funded company. 

Unlike hardware, the creation of apps and services doesn't normally require large capital outlays. And the best apps don't come from just one company or person -- they come from thousands of highly creative developers working alone or for small developer companies. Rather than compete against a large mass of highly creative developers -- by hypothetically trying to sell profitable, proprietary apps -- Apple instead offers its own apps/services at breakeven and allows developers to capture the profits from apps and services (with the possible exception of Beats Music, which Apple just purchased). This approach allows Apple to embrace and benefit from the creative efforts of thousands of developers -- creative efforts which Apple could not match in-house. It also allows Apple to embrace large, best-in-class service providers like Facebook, Twitter, and Google (to the mutual benefit of the service providers and Apple). When Apple feels it needs more control over an important service to enhance integration, ease of use, and the end user's experience, it takes steps to make the service proprietary (e.g., Apple Maps and Beats Music).

This may ultimately be the problem with Xiaomi's business model -- by relying on profitable apps and services rather than profitable hardware, Xiaomi makes the development of proprietary in-house apps/services the priority, when this kind of work should logically be outsourced to thousands of creative developers. Rather than embracing independent developers so that it can offer end users creative, best-in-class apps and services, Xiaomi puts itself in direct competition with developers.

The author owns stock shares of Apple.