Little boxes on the hillside

In my last post, I began looking at how hard it is to convince people to part with their money in exchange for software. As we said, most people buy computers and expect them to do everything out of the box; but as we saw in earlier posts, a computer is little more than an expensive doorstop without software, and new software can give your existing computer marvellous new capabilities.

We took a look at the example of Microsoft, probably the most successful (at least financially) software company in the world. One component of Microsoft's staggering success in the marketplace is that it doesn't sell directly to its users; instead it deals directly with hardware vendors, and takes a cut of the price of almost every computer sold. We also saw how almost every computer sold has only a tiny profit margin for the maker of the computer itself, and how Microsoft usually ends up doing better out of every PC sold than the company that actually makes the computer; all this despite the fact that consumers only feel they're getting value for their money for hardware, not software.

Notice that I keep talking about almost every computer sold - I can even quantify that; as of 2009, about 90% of all computers sold come installed with some version of Microsoft Windows, and usually Microsoft Office as well. Of the other 10% the only significant part are computers made by a company that is often seen as Microsoft's arch-rival: Apple.

Apple makes the Macintosh line of personal computers. Under the hood, the components that these computers are made of are almost exactly the same as those used by Lenovo, Toshiba, Acer, Dell and all the other computer makers that ship their computers with Microsoft Windows. And yet, Apple's profit margins on Macintosh computers are in the range of 30-35%. That's almost ten times what the rest of the industry makes. Apple may only have 10% of the market, but the rest of it is split up pretty much evenly between the 4-5 other major vendors; it's no surprise that Apple, with their gigantic profit margins, is still making immense profits in the middle of the credit crunch, while just about every other vendor has been hovering on the edge of profitability for years.

How can Apple afford to charge such a premium for their hardware? Two main reasons: Apple does produce slightly higher-quality hardware, placing an emphasis on industrial design and high-quality components that help sell Macintosh computers as "high-end" choices in an otherwise commoditised marketplace. However, this wouldn't be enough to sustain Apple on its own; if this was the only differentiator between Macs and Windows PCs, they would never have enough market share to sustain the company.

What Macs have that no other mainstream personal computer has today is this: They don't run Microsoft Windows. Instead, they run Mac OS X, Apple's own operating system.

The majority of the technical press agrees that Mac OS X is vastly superior to Windows, and the market seems to bear this out - a remarkably large amount of people (including the undersigned) are willing to pay a price premium on their computer purchase just to get the superior software included within. Apple only offers its computers with Mac OS X, and only offers Mac OS X for use with Apple computers. Of course, Macs - and hence Mac OS X - only have a 10% market share. The other 90% of the market either disagrees with the conclusion that OS X is superior to Windows, or is unwilling to pay the price premium. There are other reasons as well; for instance, Apple offers a limited model line-up, and many users may prefer a configuration not available in that line up but readily available with Windows from another vendor.

In a sense, Apple is doing something similar, but also markedly different, to Microsoft. Although both want to make money off their software, both have to sell it together with hardware to convince consumers to buy it. Apple does this by tying the software to its own hardware, pursuing engineering excellence and convincing consumers to pay a premium on otherwise commodity hardware using the software as a differentiator. As perverse as this sounds, it's entirely true: People are not willing to compare and purchase software independently, but they are willing to pay a premium on a hardware purchase in order to get superior software. Go figure. It's something about the shrink-wrap box and the shiny machine inside that convinces people that this is something worth paying money for. In fact, Apple is an absolute expert at the "shiny box" game - it has even started its own retail chain to present its products in their smartly designed packaging, making them objects of desire that its most loyal customers lust over. Many a Mac aficionado will tell you that the joy of opening the ingeniously devised cardboard boxes (known as "unboxing") and slowly revealing the components inside is one of the defining characteristics of "the Mac experience".

Seeing the success of Mac OS X, many technology pundits have often suggested that the best strategy for Apple, given the manifest superiority of its software offering over Microsoft's, should be to simply get into the same game that Microsoft is in: License its operating system to other computer manufacturers, possibly getting out of the hardware game entirely.

So why don't they? Hardware vendors have a love-hate relationship with Microsoft anyway; although the massive anti-trust actions against the company in both the US and EU have reigned in its more blatant anti-competitive practises, it still controls the market and sets its own prices. Wouldn't Dell or HP like the opportunity to stick it to Microsoft and use OS X instead?

Tune in for the next entry to see why this would be a monumentally bad idea for Apple. We will also be looking at other ways to monetise software in addition to retail sales and hardware bundling, and their relative merits.

Next post: It's good to be king