The Smartphone Wars: Exit Steve Jobs

Steve Jobs resigned as CEO of Apple yesterday, handing the reins to designated successor Tim Cook. It could hardly happen at a more difficult juncture – for though Apple’s cash reserves and quarterly profits are eye-popping, the company faces serious challenges in the near future. Its strategic position rests on premises that are now in serious doubt, and it is on the wrong end of a serious example of what Clayton Christensen has called “disruption from below”.

Foremost among Apple’s problems is Android. 68% of the company’s profits come from its smartphone business, and another 21% from the iPad, leaving only 11% from other sources. But Android now has #1 market share both in the U.S. and worldwide, and is growing share and customers at twice the rate Apple is.

Until very recently, the best guess was that Apple and Android have been competing less against each other than for a gusher of dumbphone conversions so vast that both Apple and the Android army were production-limited. But I have been predicting since early 2011 that this would change in mid-3Q2011 – and the first signs of that change may be upon us now. WebOS is no more, Microsoft has arrested its slide, and after a tiny post-February bump Apple’s market share is flat again. There are several possible explanations for this, but one very likely one is that Android is now putting actual downward pressure on Apple’s market share.

Apple, and its fans, had promised the world that the moment in February that Apple went multicarrier would be when it began to regain ground against the upstart Android. As I also predicted for reasons very fundamental to the one-vs.-many competition of Apple against the Android army, this has completely failed to occur; Android’s sales are still growing faster than the overall smartphone market, and Apple’s are not. Tim Cook and Apple’s board cannot possibly be stupid enough to find this un-worrying.

For all Apple’s bravado and marketing flair, it now finds itself in a position where it is running second in sales and market share and playing technological catch-up with Android handsets that have 4G capability, faster processors, and more features. Not until October at the earliest will Apple have a product that can reply to where comparably-priced Android phones are positioned now – and in that approximately two-month time Androids won’t be standing still. The launch of the Nexus Prime could easily leave Apple as far behind on the technology curve as it is now, and with no realistic prospect of recovering for many months more.

Apple’s position in tablets is also weakening. One recent study finds Android-tablet shipments have climbed to 20% of market volume. This is a huge change from three months ago when they were statistical noise. Because Apple reports units sold rather than shipped, that 20% has to be discounted by the return rate on Android tablets – but the return rate would have to be ridiculously high (enough to make front-page technology-press news) in order to drive actual Android share down to a figure that shouldn’t worry Apple.

Indeed, the tablet market looks right now quite a bit like the smartphone market did in early 2010, with the upcoming release of Android Ice Cream (4.0) ready to supercharge Android tablet sales in much the same way 2.x did for Android smartphones then. Any Apple executive who isn’t nervous about this possibility is asleep and not earning his salary.

The feeding frenzy surrounding the HP TouchPad is another cause for worry. Nobody wanted them at HP’s SRP (which was, basically, pegged to Apple’s). But when the product was canned and dropped to $150 the stores couldn’t find enough to meet demand even given the unsupported software stack. This tells us something important: it tells us that the first Android tablet with hardware comparable to the TouchPad and a supported software stack that goes below $150 is going to meet even more frenzied demand. If Apple doesn’t get to that price-performance point sooner than Android, it’s going to bleed tablet market share like someone slashed an artery.

The second of Apple’s major problems is that by opening patent warfare on Android handset makers it may have started a legal battle it can’t win. It is, in effect, claiming to own the critical design elements of modern smartphones. But Google, after having acquired Motorola’s patent portfolio, may well be in a position to reply that it owns critical design elements of all cellphones, including Apple’s.

In retrospect, Apple may have sown dragon’s teeth when it sued to have sales of Samsung tablets in Germany blocked. Apple is now going to have much more trouble attacking Google for overreach if Google files for TROs on Apple’s entire smartphone and tablet line based on a Motorola blocking patent. This is no longer an implausible scenario – and even if it does not actually happen, the threat must constrain Apple’s behavior. At this point, the best outcome Apple can plausibly hope for is a patent truce with Google that takes IP threats off the table.

The third problem Apple now has is Jobs’s successor. Tim Cook is, by all accounts, a superb operations guy and has been a perfect complement to Steve Jobs’s vision-centered style of leadership. But there is no sign in Cook’s prior performance of his predecessor’s flair. He lacks Jobs’s hyperkinetic charisma, his ability to will an entire product category into existence and instantly persuade everyone it’s the next big thing.

Tim Cook’s style is very different; where Jobs obsessed about design and coolness, Cook’s history is of obsession with efficiency and execution – one cannot escape the sense that he is more interested in supply-chain management than in how the product looks and feels. And while Cook’s focus could be a valuable trait in a stable business environment, what Apple now faces is anything but that.

I’ve said before that I think Apple looks just like sustaining incumbents often do just before they undergo catastrophic disruption from below and their market share falls off a cliff. Google’s entire game plan has been aimed squarely at producing disruption from below, and with market share at 40% or above and Android’s brand looking extremely strong it is undeniable that they have executed on that plan extremely well. The near-term threat of an Apple market-share collapse to the 10% range or even lower is, in my judgment, quite significant – and comScore’s latest figures whisper that we may have reached a tipping point this month.

For Apple, the history of technology disruptions from below tells us that there is only one recovery path from this situation. Before the Android army cannibalizes Apple’s business, Apple must cannibalize its own business with a low-cost iPhone that can get down in the muck and compete with cheap Android phones on price. Likewise in tablets, though Apple might have six months’ more grace there.

Of course, this choice would mean that Apple has to take a massive hit to its margins. Which is the perennial problem in heading off a disruption from below before it happens; it is brutally difficult to convince your investors and your own executives that the record quarterlies won’t just keep coming, especially when your own marketing has been so persuasive about the specialness of the company and its leading position in the industry. This is a failure mode that, as Clayton Christensen has documented, routinely crashes large and well-run companies at the apparent peak of their success.

Does Tim Cook have the vision and the will to make this difficult transition happen? Nobody knows. But the odds are against it.

UPDATE: I originally set the threshold for making a killing on an Ice Cream tablet at $99, but it has been pointed out to me that the $150 TouchPads with more flash sold out just as fast. And also that the single most important discriminator in “good enough” is probably a decent capacitative (as opposed to resistive) touchscreen. The difference is significant because there is nearly enough room in $150 to cover the bill of materials on such a device now; by 4.0’s release date, it should be possible to make a profit at that price point.

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