posted by alcibiades on Tue 30th May 2006 20:40 UTC
IconDell and its business model has been the focus of a lot of comment on Apple oriented forums in recent months. The Dell model is said to be unviable, and Dell's recent news is said to prove this. A limited endorsement of sorts for the so called "end to end model" in music has been published by Walt Mossberg in the WSJ. Recently a real sky-is-falling article with this theme has appeared here. This is a subject that matters. If the advocates of the so-called "end to end model" are right, it implies that the industry structure which allows us all to source hardware from wherever we want, and run a variety of OSs on it, is in danger.

We need to begin with the facts about Dell's and Apple's recent performance, and the best place to begin is Morningstar for financials and Ars Technica for market performance.

Here is the Apple Chart and financials, and here is the Dell Chart and financials

It is worth taking the time to look at them carefully. There can not be much argument about what they show. They show that for 10 years, Apple's revenues and profits have fluctuated, but Dell's have grown consistently. Ars Technica published an article about the market share and shipment trends in the PC market here. From this, you can see that in computers, Apple is basically a no growth company. Apple sold around 1.4 million machines/quarter in 1999; there was then a decline to around 800k a quarter, which lasted for several years, and we are now back to the 1999 levels. The revenue growth which the Apple chart shows is mostly due to iPod sales, which are now reported to be 40% of revenues. From the Ars charts, Apple PC market share was 4% in 1999, then fell, with some ups and downs, to a bit over 2% currently. There seems to be a lower limit of around 2%, but the trend has been steadily down for the last 5 or 6 years. In summary, Apple is not growing in computers, and its market share is falling.

Why has this happened? Two main reasons. Apple is in a distinct segment: the segment of the locked hardware/software combination. This segment has not been growing. The segment consisting of OS on hardware from a variety of sources has been growing. Second, Dell has executed better. It has controlled costs, increased share of its growing segment, and supplied what the market wanted in terms of total mix, channel, package, support.

Is Apple growing as fast as the industry in the immediate past? If you look at performance in the last quarter, you will find the industry grew at 13% quarter on quarter, and that Apple sales declined 11% quarter on quarter. As you would expect, this shows that Apple is not converting large numbers of Windows users. The number of converts buying from the US stores has gone up a little, but this rise is some thousands per quarter as a percent of 1.1 million or so total sales.

Is the predominance of the "component model" recent? No. If you want to look back at the eighties, go here. The Ars Technica material cited earlier is based on this. You will see that historically, the growth in the PC market as we know it today was driven by companies supplying hardware all of which would run the same OSs. 1985 or thereabouts was the last year in which the half of the market was supplied by companies selling a combination of hardware and software which only worked with each other. Apple is the last survivor in the PC space with this business model.

If we look at what exactly the model is, and how what Mossberg calls the "end to end model" differs from what he calls the "component model", it may not be clear at first what the difference is. In fact, to use these names is to misrepresent the situation. Apple and the other PC suppliers such as Dell use identical hardware and components. The OS they ship is always preinstalled, and relates to the standard hardware in exactly the same way. Both methods result in solutions which work as a whole when taken out of the box and switched on. They distribute in the same ways, often through the same channels. They manufacture using the same OEMs and they have the same discussions with them about form and function and features. There is a variation in whether the OS is developed in-house, as Apple's is, but this is not the key difference. Consider that Apple would still be following its current model if it distributed an outsourced OS, but still locked it so it only ran on Apple branded hardware. Linspire would not be following the Apple model if it shipped PCs with Linspire preinstalled as long as it sold unlocked copies of Linspire separately, for customers to install on whatever they wanted. Lock the OS to the hardware, and this would be the Apple model. The essence is not whether the OS is developed in house. The essence is, whether it is locked to the hardware.

In short, it is DRM. The real difference that characterises what is misleadingly called the "end to end model" is that you cannot buy OSX compatible hardware anywhere but from Apple. Apple has no competition for Mac hardware. This is the only thing that is different. It is not that one model is in any meaningful sense more end to end than the other. Let's ask two questions about this. First, what effects has it had?

It has permitted higher prices and a higher lifetime profits for Apple. Over the years of owning an Apple, you pay Apple pretty much annually for software upgrades, and you pay a higher price initially for the hardware/software combination. Dell gets nothing from Service Packs. This adds up to an average percentage margin difference of around 15 points. Apple's margins are about 30%, Dell's are about 15%. Check out Morningstar to confirm this. It has also permitted Apple to milk the base. If you are locked into OSX, you have to pay the Apple price to get your next hardware. If you're running Windows, you can get your next machine from anyone you like.

People sometimes argue that Apple can have higher margins without its customers paying more for the same things as the Dell customers, just by selling more stuff with the machine. The argument appears frequently on OSViews. It doesn't however work, mathematically. If the cost of goods sold for a machine is 850 for each company, Dell would sell it for 1,000. Now Apple would somehow sell these same parts and others for a 30% total margin. Assume the margin on the extra parts is 50%. How much would the bundle have to sell for? Suppose it sold for 2000, i.e. double. That would give margin of 575, which is just about 30%. This is not what we see in the market, and it is also not what the people who offer this argument say. They claim, on the contrary, that Apple somehow gets its 15 extra margin points by selling products which are similarly priced. It is not possible. The only place these margin points can come from is the customers.

Does this mean Dell and its peers are selling a commodity, like generic aspirin, and doomed to compete solely on price? Does it mean Apple is selling solutions and Dell a commodity or components? No. Dell et al are selling solutions, competing on all elements of the product mix, in a market which is very price competitive. It's different. Dell strives to be the low cost producer, but that does not mean it competes on price. It doesn't even mean Apple is not selling a commodity. There is a difference between having eliminated competition for a commodity you sell, and it not being a commodity at all. Ask De Beers! However, keeping these prices and these margins and eliminating competition does have its own price. It's called elasticity, and it has limited Apple's sales and market share by lowering demand.

Second, is Apple's a more viable model? No, there is no evidence at all for this. We have seen from Morningstar that Apple has not performed any better than Dell. We've seen from the Ars Technica material that the Dell model accounts for some 97% of global PC sales. Apple is the only survivor using its business model, and no-one has tried to enter the industry recently using it. What the HP/Compaq merger, and what the well publicised difficulties of some suppliers shows is, that it is a very competitive market. Margins are thin. Players get into difficulty. Sometimes they go bust or merge. But this is not the model being unviable or vanishing. This is the model working. What would prove the model to be unviable would be new entrants supplying OSs which would only run on their hardware, and for players with this business model to start dominating the PC market.

Relax, there is no sign of it happening, and there has not been for twenty years.

--alcibiades


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