Apple’s Ecosystem Elasticity and Killing the Middle Men

Apple’s new subscription model is genius, and its sizing offers insight into their strategy.  As a sometime poker player, I can only whistle at the size and audacity of the bet they are making.  The best framework to analyze their move is game theory, and poker works as well as anything.

Why Apple is making the right bet.

Apple’s new rules are being labeled as subscription rules, but they really are mainly about content sales on Apple hardware, with the subscription model being the red herring. The key provision is that any content you pay for to consume from within an iOS app is available at parity pricing from within the app.  If you pay for it from outside of the app, you don’t need to pay a rev share to Apple, but if you pay for it from within an app, Apple keeps 30%.  Doesnt matter whether the model is per piece or subscription.

Apple understands that content is king, but UX is queen. (damn, a chess metaphor in my poker framework).  Simply put, the user experience of buying content via the App Store is going to be better than the user experience of buying content elsewhere.  The UX gap is a straight up tax that guarantees that most content consumed on apps will be purchased through the app store.  Without having to be in the content licensing or curating business, Apple is demanding that they get a cut of all media consumed in apps running on their hardware.  This is where you whistle at the audacity and size of the bet, because you know they have cards and are not bluffing.

In poker, the sizing of bets is everything.  A perfectly sized bet makes the bettor indifferent to whether his opponent calls, raises, or folds based on the probabilities involved.  Apple’s bet size today is 30%.  That is a very very large number in the scheme of things because it is greater than the profit margin for most types of content.  If you are a content middle man like Netflix or Amazon you have a very tough decision to make.  Call with a weak hand, or fold and pull your products out of the App Store.  If you stay in the hand you need to raise your prices, so you probably need to set up a two tiered pricing model which is difficult.

My initial intuition here was that the 30% number is a skosh too high, and that for certain content types they would need to negotiate new deals, which they don’t want to have to do because a one-size fits all model is operationally so much more efficient.  But upon further reflection their bet feels about right, because their aim is to wipe out the middle men outside of niche content types that can survive under the 30% royalty.

The reason Apple has put its ecosystem partners to the test with this audacious move is that they want to really stress out content middlemen (other than themselves).  The 30% surcharge is going to make aggregation and curation a much harder business, and force the content owners to deal with Apple directly.  If Apple gets 30% from the purchase of your movie either way, you are going to have a harder time keeping your film out of the Apple Store.  Basically content aggregators who want to offer content on Apple devices can never offer a better revenue split than 70-30.  If Apple turns around and offers 70-30 revenue split deals to all of the studios, they need to say yes to be maximizing revenue on Apple devices.

Opening for Android

Apple has really thrown down the gauntlet vs. Android today, and in doing so placed an enormous amount of pressure on itself to continue to offer the best media consumption devices across all of its form factors.  The obvious move for Google now is to NOT charge any kind of content surcharge towards aggregators in the Android app store, and hope the ecosystem collectively puts more resources against the Google platform and slowly narrows the quality gap between Android and iOS devices.  Apple is betting that their more tightly integrated products, bolstered and funded by the massive margins they will create through content licensing, allows them to deliver a better user experience that justifies their higher content prices and maintains or grows their market share.

Personally I love Apple’s strategy here.  It is very innovative and shrewd, and nobody in the market can imitate it.  It is disruption-proofed, because unlike Microsoft’s PC OS hegemony it applies across all screens and popular form factors.  And maybe most importantly, it creates an internal imperative to innovate and create the best user experiences, or it all comes apart hard.  If it works, Apple will have an unassailable market position for a long time to come.

UPDATE:  Apparently, Apple was overplaying their hand a little bit.  They have relaxed their requirements and are allowing apps to play content purchased outside the app store, with the condition that the content can’t be offered for sale from inside the app.  This seems like a rational move, and a nice compromise.  Apple is still betting that apps that don’t provide in-app purchasing will suffer in the long term.

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  • Anonymous

    Doesn’t this screw consumers bigtime? I agree its disruption-proof — even slowing disruption of businesses Apple will never get into.

  • Ty Danco

    My first thought was, sheepishly, the old joke about “why does the dog lick ‘himself'”, with the answer “because he can”. And while Apple is obviously more than aware of the reasons why its closed system almost killed it back in the days of the PC, this is, as you say, interestingly different. It’s open…for a price. I’d be curious if any anti-trust experts can opine on how much of the market they need to be targeted for anti-competitive practices. But in the meantime, they’ll be laughing all the way to the bank. Heads they win, tails…they make a bundle in the shorter term while they think of the next frontier to innovate in.

  • Bill

    You have nailed it! Apple’s policy is aimed directly at the middlemen who leech off it’s ecosystem. Customerscwill likely benefit. And amazon, hulu and the others will be gone. And then the studios, publishers, etc will have to decide whether to expand their content offerings on iOS.

    And spotify is dead.

  • steveray

    IMO consumers on balance will be OK because Apple never really gets monopoly power, and they need to keep innovating and moving forward to maintain their overall quality gap and premium pricing. if you just want to watch Blazing Saddles on a generic screen, you have cheaper options. If you want to watch it on your iOS device you need to pay up.

  • steveray

    I don’t think they are anywhere close to anti-trust territory here. Unlike Microsoft 10 years ago they aren’t seeking a monopoly, only to corner the high-end of the market.

  • steveray

    well, leach is a pretty strong word. I wouldn’t consider Netflix a leach for example, they add a lot of value in curation, organization and biz model innovation – their products are great and highly differentiated from iTunes.

  • scyphers

    I’m a bit more inclined to think of this move as adding another layer of bricks to the walled garden. Sure, Apple wins when it comes to UX. But I believe they are open to an Innovator’s Dilemma type of challenge coming in the “good enough & cheaper” approach of Android.

    I know that for my startup, we’re betting on HTML 5 as a cross-platform mobile strategy; we’ll be going to Android as our first platform of choice for the greater market penetration.

  • Anonymous

    “And then the studios, publishers, etc will have to decide”

    Historically these entities have been very very VERY bad at making decisions, especially for their customers.

  • Anonymous

    And, the opportunity for another Netflix is severely hampered now. If you want a new idea in content distribution, you will have to wait until Apple thinks of it.

  • msuster

    I agree that it was a shrewd move in the short-run. In the long-run my gut says Apple is overplaying its hand. They have been a benevolent dictator for years but are now displaying some levels of ruthlessness that will drive valuable potential partners into rivals hands.

    I think your analysis that they are the best content discovery & consumption UX by a long shot and that’s what gives them power is spot on. As long as they continue this they are a in a strong position.

    But in the long-run I’d be on market forces every time. Long live democracy, down with dictators.

    Signed, the guy who just traded in his HTC Incredible for an iPhone.

  • steveray

    To me the key to understanding Apple (having had my ass kicked by them in the digital music space) is that they are not trying to build products for everyone, they are trying to build Apple products for people who want Apple products, and letting market share grow as a function of that. Everyone points to their early 90s loss to Wintel machines as their Waterloo with the walled garden strategy, but it could be that it was the exception that proved the rule, and it just happened to happen first.

    I thought of you last night when Tosh.0 called Blackberrys “phones for old people who are frightened of typing on their iPhone screens”.