I was listening to the MacWorld podcast recently when an interesting question popped up. Would Apple (AAPL) ever make iTunes purchases available to Android users? The consensus on the show was that, no, Apple would never do that because it’s not the type of thing that they would do.
I don’t disagree with their consensus but I think it goes a little deeper than that. There’s a very clear cut financial rationale underneath Apple’s whole walled garden. I don’t think Apple follows their walled garden paradigm only because the economics make sense. There’s a lot to be said for Apple being able to enhance the customer experience by developing both hardware and software in tandem. This is the true driving force behind why Apple hasn’t traditionally made their products cross-platform. But they still take into account the financial feasibility of any of their overarching principles.
When it was announced that Apple Music would be available on Android it surprised a lot of people. So why would Apple appear to be inconsistent with their doctrine?
I'm not so sure that Apple is being inconsistent. Apple generally goes where the money is. When the walled garden doctrine and quest for increased revenue are in support of one another, there is no controversy.
But Apple has demonstrated a willingness reevaluate their stance on a principle if it begins to conflict with their financial modelling. Case in point, Apple believed that having one-handed usability on the iPhone was more important than increasing the screen size. However, when the financial analysts detailed how much revenue they could be missing out on, they changed course and now we have screen sizes of up to 5.8”.
In the case of enlarging iPhone screens, it would be a fairly simple problem to figure out how much revenue they might gain. When you evaluate a proposal financially, you create two models. One model is the control group and will quantify your sales and gross margin if you don’t change anything for the next five years. The other model will quantify the changes and compare to your control. The amount of additional revenue is your return on investment (ROI). The Apple sales forecasters would estimate how many more iPhones they could sell if they had a large screen model. They could then multiply these additional units by the average sales price and gross margin to see the incremental impact.
Offering iTunes on Android is a much more complex question. It’s not just a straight forward addition of media revenue. There is also the potential loss of units in the iPhone side of the business. Apple’s walled garden makes iOS a very sticky ecosystem. The iPhone retention rate compared to Android is significantly better. According to Tim Cook, Apple gains more Android users than they lose. So, when Apple financial analysts evaluate the impact of offering services on Android, they need to take into account a possible reduction in the iPhone retention rate.
Just for the sake of argument, let’s say that Apple has a retention rate of 92%. Meaning that every year Apple loses 8% of their customers who switch to some other brand. If Apple started making their services cross-platform and their retention rate were to fall down to 90%, what do you think would happen? In my financial model, a 2-point reduction in retention rate equates to a loss of $2.8 Billion in revenue per year. If the retention rate were to drop 5 points that would mean a loss of $7.1 Billion.
At a 5-point erosion in retention rate, $7.1 Billion becomes the break-even point that the iTunes side needs to make up. That’s a whole lot of additional iTunes purchases that needs to come in just get to zero, let alone make a return. Especially when you consider that all Apple services totaled to around $30 billion in the last fiscal year. And that includes iCloud and App Store revenue that wouldn’t go up.
So what does this all mean? It means that Apple is very unlikely to ever offer an iTunes media app for Android. The risk to their retention rate is too great in relation to the potential benefit. This is an oversimplified example just to make a point. In reality, a reduction in the iPhone retention rate would have other ramifications besides just lost iPhone revenue. There would be a corresponding loss of iCloud, iTunes, Apple Watch, and perhaps other business.
So why did they offer Apple Music on Android? Because this was something new. They weren’t giving up any legacy advantages. Data stored in iCloud or movies stored in iTunes are legacy systems which keep you in iOS. Streaming music is not. By its nature, it’s ephemeral. The risk that Apple would hurt their iPhone retention rate is much smaller and all the Apple Music revenue would be incremental. There was probably more risk in not having a music streaming service. The risk-to-reward ratio swings in the opposite way as offering iTunes on Android.
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When it was announced that Apple Music would be available on Android it surprised a lot of people. So why would Apple appear to be inconsistent with their doctrine?
I'm not so sure that Apple is being inconsistent. Apple generally goes where the money is. When the walled garden doctrine and quest for increased revenue are in support of one another, there is no controversy.
But Apple has demonstrated a willingness reevaluate their stance on a principle if it begins to conflict with their financial modelling. Case in point, Apple believed that having one-handed usability on the iPhone was more important than increasing the screen size. However, when the financial analysts detailed how much revenue they could be missing out on, they changed course and now we have screen sizes of up to 5.8”.
In the case of enlarging iPhone screens, it would be a fairly simple problem to figure out how much revenue they might gain. When you evaluate a proposal financially, you create two models. One model is the control group and will quantify your sales and gross margin if you don’t change anything for the next five years. The other model will quantify the changes and compare to your control. The amount of additional revenue is your return on investment (ROI). The Apple sales forecasters would estimate how many more iPhones they could sell if they had a large screen model. They could then multiply these additional units by the average sales price and gross margin to see the incremental impact.
Offering iTunes on Android is a much more complex question. It’s not just a straight forward addition of media revenue. There is also the potential loss of units in the iPhone side of the business. Apple’s walled garden makes iOS a very sticky ecosystem. The iPhone retention rate compared to Android is significantly better. According to Tim Cook, Apple gains more Android users than they lose. So, when Apple financial analysts evaluate the impact of offering services on Android, they need to take into account a possible reduction in the iPhone retention rate.
Just for the sake of argument, let’s say that Apple has a retention rate of 92%. Meaning that every year Apple loses 8% of their customers who switch to some other brand. If Apple started making their services cross-platform and their retention rate were to fall down to 90%, what do you think would happen? In my financial model, a 2-point reduction in retention rate equates to a loss of $2.8 Billion in revenue per year. If the retention rate were to drop 5 points that would mean a loss of $7.1 Billion.
At a 5-point erosion in retention rate, $7.1 Billion becomes the break-even point that the iTunes side needs to make up. That’s a whole lot of additional iTunes purchases that needs to come in just get to zero, let alone make a return. Especially when you consider that all Apple services totaled to around $30 billion in the last fiscal year. And that includes iCloud and App Store revenue that wouldn’t go up.
So what does this all mean? It means that Apple is very unlikely to ever offer an iTunes media app for Android. The risk to their retention rate is too great in relation to the potential benefit. This is an oversimplified example just to make a point. In reality, a reduction in the iPhone retention rate would have other ramifications besides just lost iPhone revenue. There would be a corresponding loss of iCloud, iTunes, Apple Watch, and perhaps other business.
So why did they offer Apple Music on Android? Because this was something new. They weren’t giving up any legacy advantages. Data stored in iCloud or movies stored in iTunes are legacy systems which keep you in iOS. Streaming music is not. By its nature, it’s ephemeral. The risk that Apple would hurt their iPhone retention rate is much smaller and all the Apple Music revenue would be incremental. There was probably more risk in not having a music streaming service. The risk-to-reward ratio swings in the opposite way as offering iTunes on Android.
Now available in iBooks —> The Tesla Bubble
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