Strategic Analysis: Apples Innovation vs. Microsofts Pricing - Term Paper Example

Strategic Analysis: Apple’s Innovation vs. Microsoft’s Pricing Introduction Apple Inc. and Microsoft Corporation are prominent, technology-based firms that compete in the computer market. Specifically, they offer competing computer operating systems, the core software that controls how users operate computers, software and peripheral products. Measured by the fundamental strategic goal of creating sustainable competitive advantage, each firm has been successful. But their business strategies have been significantly different, with Apple emphasizing innovation and Microsoft emphasizing low pricing. This paper compares and contrasts these strategies and seeks to determine whether one strategy is better than the other. Apple Strategy Since its founding in 1976, Apple Inc. has been an innovator, but its 1984 introduction of the Macintosh personal computer began a 25-year period of important innovations in operating systems. Successive versions of Apple’s computers and operating systems made computers easier to use, faster, smaller, and capable of handling more tasks. In addition, especially compared to Microsoft’s operating systems, Apple’s have always been much less susceptible to online threats from hackers, viruses and spyware, a key strength for the large and growing volume of online activity. Apple’s technology innovations helped establish the market segments for personal computers (in addition to mainframe and mini computers) and for home-based computers (in addition to the business market), and Apple continues to be recognized as a technological leader. Yet today Apple only has about 8% share of the unit market for personal computer operating systems, primarily because even today its prices remain at least several hundred dollars higher than PC prices. (Foresman, 2010) When it comes to operating systems, Apple seems content to focus on being the leader in a relatively narrow niche of the computer market. To this end, Apple has three innovation strategies: be an innovator of computer operating systems; be an innovator in marketing strategies; and be an innovator in non-computer products. The last two strategies are discussed below: 1. Exclusive Retail Distribution Apple’s retail distribution is innovative in that it uses dedicated retailers rather than share counter space with other computer manufactures. Although this can increase relative distribution costs, it has several marketing advantages. First, the entire selling/buying experience is focused on Apple products and thereby strengthens Apple’s marketing messaging and facilitates customer attention. In addition, the clientele tends to consist of new and longtime Apple product users, which serves to enhance a feeling of being a special population of customers. 2. Complementary New Product Lines While expanding its product offerings well beyond personal computers, Apple has focused on personal technology products that complement each other, are easy to use, appeal to overlapping customer segments, have common branding and often having breakthrough functionality. For example, the iTunes and iPod work together; along with iPhone and iPad, they appeal to similar consumers; and along with iMac, they reinforce an increasingly strong brand name. Taken together, these individual tactics help create a strong, positive image for Apple as a company, for its current product lines and for eagerly-awaited new products. Apple seemingly does not sell products, it sells a continuing relationship. 3. Target Education Market Apple was an innovator in targeting primary, secondary and college level schools with special buying incentives as one strategy to help establish itself with future generations of computer buyers. In effect, it converts classrooms into product showrooms. 4. Next Generation Customers Considered together, Apple’s strategies for complementary new product lines and targeting the education market have helped establish the Apple brand with younger consumers, the next generation of personal technology buyers. Equally important, Apple has done this without losing its core customer base of “nerds” who consider themselves to be the most knowledgeable and “hip” about personal computers. Apple seemingly does not just sell a product, it sells a lifelong relationship with customers in its target niche. 5. Promotion Apple has been innovative in promoting the company and its products. It commands significant attention from the media, in part because of its unique and interesting new products, but also because its annual new product announcements have become major events that are much-anticipated by media of all types. In addition, Apple also has a celebrity in its founder and CEO, Steve Jobs, who has become a well-recognized and important spokesperson for new personal technologies. Finally, Apple has actively worked with new media such as online technical blogs that can help reach current and new customers. Apple seemingly does not sell technology, it sells high tech excitement. 6. Product Packaging Apple’s products have a long and innovative history of being both physically attractive and reinforcing the image of the product and the company. They are typically sleek, as leading edge personal technologies are expected to be, and they often employ striking color schemes and logos. Again, Apple seemingly does not sell technology, it sells high tech excitement. 7. Market Research Apple’s success in marketing and new product innovations cannot be a matter of luck. Rather, it argues that Apple has a strong and innovative market research capability that understands the needs, wants and interests of its target customer segments and how to satisfy them. Understanding these issues is essential to creating and keeping customers. Microsoft Strategies Microsoft was founded in 1975 and for five years focused on developing certain relatively modest computer-related software and hardware products until it introduced its first operating system in 1980. Then, in 1981, IBM Corp., which was working on introducing a personal computer (PC), awarded Microsoft a contract to supply the PC’s operating system. The first system (called Disk Operating System, or DOS) that Microsoft supplied to IBM was actually a version of a system that Microsoft licensed from another company. Microsoft priced its system at US$40 per unit, significantly cheaper than two other operating systems IBM had at prices of US$450-550. (Spector, 2001) The contract with IBM was the basis of a new Microsoft business strategy that it essentially still follows today. 1. Volume-Driven Pricing In 1981, IBM was the very dominant supplier of computers primarily because it was always the safe choice for all major customer segments, including business, government and military. With the IBM contract, Microsoft was now partnering with the world’s computer market leader that had vast resources to ensure success of its new PC and Microsoft’s operating system. But Microsoft also benefited from another development that was a direct threat to IBM: other computer manufacturers quickly began to “clone” the IBM PC and Microsoft was in an advantaged position to supply their operating systems as well. The result was that, regardless of which PC-based brand was sold, Microsoft benefited, and thus became by far the dominant supplier of operating systems. According to one source, based on 2009 unit shipments of personal computers in the U. S. market, Microsoft accounted for about 90% of the operating systems. (Foresman, 2010) Microsoft became a prime example of the economics-driven, high-volume leader enjoying the lowest cost per unit and thereby able to afford offering the lowest price per unit. Combined with growing, worldwide competition among the computer manufacturers, Microsoft’s economics supported a steady downward spiral in PC prices. Compared to today’s inexpensive machines, IBM’s first PC was a “$1265 base model didn't include a monitor, a video card, a parallel or serial port, an operating system, or a floppy drive.” (Spector, 2001) Moreover, because software manufacturing costs do not appreciably increase with increased volume, Microsoft’s absolute financial advantage could increase at a great rate than volume increases. This enables Microsoft to invest incremental amounts in development and marketing to further strengthen its dominant market position. Microsoft’s market share and price leadership are so large that they triggered an antitrust suit from the U.S. government alleging Microsoft was harming competitors because it was incorporating new capabilities in its operating systems at no added cost to customers. The suit was settled in 2007. A similar lawsuit by the European Commission was settled in 2009. There has been much media speculation about an impending battle between Microsoft and Google, the giant search engine company, in part because Google in 2009 announced plans for an operating system to compete with Windows. It is too early to speculate about what this means for Microsoft’s low-price strategy, but given Google’s financial and technical resources, it could be significant. 2. Product Innovation Until recently, Microsoft’s operating systems have never matched, much less surpassed, the ease of use, functionality or safety of Apple’s systems. This position of second tier quality persisted despite several decades of development efforts that produced a seemingly endless series of Windows-branded products, including Windows 3 (1990-1995), Windows NT (1993-1996), Windows 95, Windows 98, Windows 2000, Windows ME (2000), Windows XP (2001-2007), and Windows Vista (2007-2009). In fact, Windows Vista was widely considered a technical and market failure. Microsoft seemed to simply lack the innovation skills to match Apple. However, Microsoft over the years has assembled a very broad range of leading software applications. For example, Internet Explorer is a leading web browser, not only because it is bundled with Windows, but also because it is functionally competitive with other browsers. In addition, Microsoft has a leading market position with important, non-bundled applications such as Word, Excel, PowerPoint and others. To some extent, this has been due to acquisitions rather than pure internal development: the company has made well over 100 acquisitions of technology companies (compared with about 20 acquisitions by Apple). (Alacra, Inc., 2010) In addition, of course, Microsoft was in the controlling position to ensure that its software offerings were optimized to work with its dominant Windows systems. Importantly, Microsoft may have finally improved its innovation record with the 2009 release of its latest operating system, Windows 7. It has been widely praised as virtually matching the functionality and ease of use as Apple’s latest operating system known as Leopard, which was also released in 2009. Microsoft also recently achieved another positive product innovation with its 2009 release of a new web browser branded as Bing. Designed to compete with Google, it has received favorable reviews, although it is not considered to be as good as or better than Google for most types of searches. In support of its strategy to compete with Google, in 2009 Microsoft also announced an agreement to provide the search engine capability for Yahoo websites. This agreement follows several years of merger discussions between the two firms as well as a hostile takeover bid that Microsoft made for Yahoo in 2008. This history suggests that there may be more developments between the two firms. Together with its Windows 7 success, these developments may be signaling a turnaround in Microsoft’s product development capabilities and perhaps its innovation strengths. Nevertheless, it does not seem likely that product innovation will soon surpass or even equal Microsoft’s dependence on its volume-driven pricing strategy. Strategy Assessments It seems clear that, despite their fundamentally different strategies, both Apple and Microsoft are successful companies, because each has become among the largest 100 U.S.-based firms (as ranked by annual revenues by Fortune magazine) since being founded a little more than 30 years ago. In order to assess whether one strategy – Apple’s innovation or Microsoft’s low pricing – is better than the other, there are several different measures one might consider. 1. Market Share One obvious measure is the relative success of each firm in the specific market segment in which they are direct competitors, computer operating systems. As noted earlier, in 2009 Apple had an 8% share vs. Microsoft’s approximate 90% share. By this measure, Microsoft has been by far the most successful supplier of operating systems, so its strategy has been better than Apple’s. 2. Financial Performance Another measure of the quality of strategy is the financial results it produces. Financial data is not available to examine specific financial results for each firm’s operating system business alone, so I will rely on each firm’s total financial performance. To some extent this is justified because operating systems are the largest part of each firm and provide the resources to pursue additional corporate opportunities. The table below shows several latest measures of each firm’s overall financial performance, including total enterprise value (equity plus debt), latest 12 months annual revenue and latest 12 months overall operating profit margin. (Yahoo! Inc., 2010) Selected Financial Performance as of March 2010 (US$ Billions) Enterprise Value Annual Revenues (trailing 12 months) Operating Margin (trailing 12 months) Apple $174 B $47 B 29% Microsoft $223 B $59 B 28% Compared to Apple, Microsoft has a larger enterprise values and greater revenues, each of which is a measure of overall corporate success. Therefore, this measure too shows a clear advantage for Microsoft and so its strategy has been better. 3. Shareholder Returns A third measure considers the rate of return to each company’s investors (dividends plus stock) generated by each company’s strategy. To some, this may be the single most important measure of overall corporate performance, but in any case it is among the most important. The table below shows one analysis of shareholder returns over two successive period during the last 20 years: (Carnevale, 2010) Annualized Rate of Return 31/12/1990 – 29/12/2000 31/01/2001 – 02/03/2010 Apple -3.6% 3.8% Microsoft 35.4% -0.7% S&P 500 14.9% -2.4% This analysis shows a clear change in relative performance since 2001 compared to the previous decade. In the 1990-2000 period, Microsoft’s shareholder return not only far exceeded Apple’s, it also far exceeded the overall return of 500 major firms comprising the Standard & Poors index. In fact, Apple’s negative return is particularly surprising because it occurred during a period of overall positive growth in the U.S. economy. However, since 2001, relative performance between the firms reversed, with Apple taking the lead. Even though the 2009-2010 recession probably reduced all the returns for the full period, nevertheless Apple managed to generate a positive return whereas Microsoft had a slightly negative return. This measure suggests that Apple’s strategy may be becoming better than it was in the previous period and also becoming better than Microsoft’s strategy. 4. Customer Satisfaction This measure is not quantified and is essentially based on popular opinion. Nevertheless, the general impression is that Apple customers have long been very pleased with its operating system, whereas Microsoft customers merely tolerate Windows and remain customers primarily because of the much lower PC prices. With the recent success of Windows 7, it is possible that Microsoft customer satisfaction will improve. 5. Future Competitive Advantage A final measure of whether one strategy is better than another is based on how well each firm’s strategy has positioned the firm for competition in the future. In the case of Apple, its innovation-based strategy has built a leadership position in a relatively small but attractive niche market, helped create strong marketing capabilities and promoted development of many new personal technology products. These factors seem to provide a strong base for competing in the future. In the case of Microsoft, its low-price strategy has built a dominant position in a large and still-growing market and has provided the financial strength to acquire new complementary technologies, possibly including acquiring strong firms such as Yahoo. Therefore, by this measure, neither strategy seems better than the other. Conclusion Apple and Microsoft have both been very successful companies, and there is no definitive evidence that shows either of their business strategies to be clearly better than the other. This may be due to several reasons, such as the different market segments the firms targeted, the ability to acquire rather than internally develop important technology and the spectacular growth of the overall computer market. It might also be due to Bill Gates’ luck in landing the IBM contract. Bibliography Read More