Monday Note #205 - Apples Antitrust Problem - iTV Wheres the Money

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From: Monday Note <[email protected]>Sent: Sunday, November 13, 2011 11:11 AMTo: Murray, Patrick JSubject: Monday Note #205 - Apples Antitrust Problem - iTV: Wheres TheMoney?

Monday Note #205

November 13, 2011Edited by Frédéric Filloux [email protected]

Apples Antitrust Problemby Frédéric Filloux(First in a series)Will Apple face the type of antitrust issues Microsoft had to contend with in the 90's?Possibly, but not with the same magnitude. Apple is by no means locking up its market the wayMicrosoft controlled the personal computer field with Windows. Still, the questi

on arises for theiTunes Store, the App Store and their tightly controlled transaction and subscription systems.Today, well take a look at the issue from a news business perspective.The fact that scores of publishers are flocking to the iTunes system doesn't mean they arehappy with it. For any publisher willing to access the burgeoning tablet marketcurrentlydominated by the iPad, a presence in the AppStore is mandatory. But I never meta publisherhappy with his relationship with Apple. For most, what started as an enthrallingpartnership isslowly morphing into a feeling of servitude.

That perception is tinged with schizophrenia. Media people are usually fond of Appleproducts. From top bosses to tech reporters, they cherish their iPads and theiriPhones. Then,each time Apple introduces a well-polished new device, it gets glowing coverageworthhundreds of million dollars if converted in media space.Enjoying great products and admiring Apple for its many achievements does not preventanyone from taking a stern look at the way the Cupertino folks do business. In anutshell,publishers feel increasingly locked-in, and sometimes abused by Apple's tight ec

osystem.As always, there are excesses on both sides. Difficult as it might be, let's tryand take abalanced view of three majors issues:#1 the Application ecosystem#2 the validity of a business model build on a 30% commission#3 the issue of the customer data.(We'll start with #1 today, and address #2 and 3 next week)The following is based on my ongoing contacts with publishers and conversationsI had withlawyers specialized in antitrust and intellectual property. They spoke anonymously as they arequietly loading their guns for a possible legal action before the European Commi

ssion.#1 The App EcosystemThe context. Apple set up a huge technical and human infrastructure in order to



provide toolsto anyone, large of small, willing to build an application and yearning to makeit available to anymarket. Amazingly, from the outset, Apple decided to provide all this machinery(softwaredevelopment kit, tracking system, testing) for free (let alone the symbolic costof a $99

developer account).Entrepreneurs voted with their keyboards and mice: there are 500,000 applications in theAppStore today, and counting. It created a huge new business. As Apple gives back 70% of therevenue for paid-for applications, by June 2011, the company had paid over $2.5Btodevelopers, many of them individuals or very small companies.Well, is there really a matter to complain about here?Surely not for the developer working from a high rise in Seoul or a barge in Amsterdam. But forthe large publishing company, its another story. Once it enters the system, two k

eywords beginflashing : "discretionary power" and "locked-in".Let's face it, Apple has life and death power over the apps it harbors in its store. Its approvalsystem it completely opaque, left at the discretion of an elusive army of peopleworking atundisclosed locations. Welcome to the kingdom of the arbitrary. The same set of features thatonce raised a red flag triggering a rejection will be accepted the next time around -- withoutexplanation. Approval delays vary widely, making it difficult to plan the roll-out of a criticalproduct. What is acceptable for a mom and pop operation becomes anxiogenic for l

argeorganizations.The question of "choice". To those who criticized its "black box" system, Apple's retorts weevolve in a free market: if a publisher is not happy with its App Store it can:(a) go to theAndroid market, or (b) build its own web-app, i.e. an app that will live and functionindependently of the iTunes Store.Antitrust lawyers don't see things that way. Their argument: for someone controlling 75 % of thetablet market, invoking such a marginal alternative isnt relevant. A publisher willing to join thetablet business has no choice but being available on the iPad. In practical terms, this meansinvesting serious money to join a platform operated in a discretionary and opaque way, withunclear and changing rules.As for the web app, antitrust attorneys suggest they represent a degraded and dangerouslyuncertain alternative to the iTunes Store. Degraded because a web app such as the FinancialTimes' -- the poster child of the "resistance" to Apple -- doesn't work as wellas a native app.And this notion of "slightly less good" is absolutely critical. Given the sate o

f HTML5 (theprogramming language used for independent apps) and whatever the skills of its developers, a



web-app will never be as fast, as fluid, as features-rich as a native application. As for theuncertainty, it lies in the fact that a web-app depends on features Apple can change withoutwarning, such as the ability to use its browser (no choice here, it's Safari) tostore content. Putanother way, web-apps are likely to work -- no more than OK -- until Apple decid

es otherwise.Again, its difficult to build a sound business upon such quick sand.Evidently, Apple is entitled to defend the integrity of its operating system bynot givingindependent applications access to critical layers of its iOS. This precaution provides bettersecurity against rogue code such as viruses and other malware; it is an indisputable justificationfor tight control. Agreed, said the antitrust lawyers, but: (a) for the native apps, rules could bemore transparent and stable, (b) as for web apps, such rules should evolve within a framework

of well-documented Application Programming Interfaces (APIs), a set of coding conventionsused by programs to communicate with each other and with the underlying operating system.These APIs would be controlled by Apple on the sole basis of technical concern in order toprotect the integrity its OS while creating a clear and well-defined framework for publishers.Evidently, these suggestions sound a bit naïve. Apple has no business interest whatsoever ineasing its allowance for independent web-apps. Most likely, it will carefully adjust the cursor toappear reasonably open while, at the same time, protecting its own ecosystem.

Things are likely to get worse before they get better: Apple is likely to unleash features thatwill benefit only applications and services of its choice in order to preserve its position. The bestexample is its Newsstands background downloading for publications (your iPad automaticallywakes up to download the publications you subscribed to in the Newsstand, see apreviousMonday Note on the matter). Lawyers says this is the perfect example of a feature that createsan unfair advantage favoring Apple's own distribution channel.Apple's attitude towards competition epitomizes a often-seen scenario of thetechnological evolution: a company acquires a dominant position in a given market (intodays case, several ones) thanks to superior products and services. As the company furthergains ground over its competitors, the admiration for its quick success morphs into growingsuspicion. Features that once were lauded as innovative market boosters begin tobe seen asinstruments of a market lock-down. At the same time, competition tries to imitate the leader asfast as it can. As it feels both unfairly copied and threatened, the market leader reacts by furthertightening its grip on its business, using whatever it takes to buy time. In doi

ng so, it triggersmore hostility, etc. A vicious spiral begins.Next week, considering market domination, we'll see why Apple takes a different



approach fromthe one Microsoft once used. Unless it becomes completely intoxicated by its ownsuccess, aclever "cursor adjustment" could preserve Apple's lead and, at the same time, favor [email protected]

iTV: Wheres The Money?by Jean-Louis GasséeIn reaction to last weeks technical speculation on the putative iTV, several commentersraised questions about content providers, distributors, and pipes. Does iTV help or harm NBC,Netflix, and Comcast? How does the [one last time: putative] iTV make money, and for whom?Indeed, the column ignored an important perhaps the most important -- part of the product:the Money Pump, a.k.a. the Business Model. While Apple displays a sharp, fulfilling sense of

aesthetics and simplicity in the design and implementation of new products, thecompany didntreach the pinnacle of high-tech profitability by merely practicing lart pour lart.Apple isnt deafto a more practical art form: cash register music.Starting with pipes, lets look at smartphone carriers as an analogy. When AT&T won exclusive iPhone distribution rights in the US, it appeared that they had tradedtheir birthright.The iPhone bore no AT&T customizations, no stickers, no craplets. Worse, the carrier had to letApple run the content distribution table with iTunes.As weve since seen, the trade turned out well for AT&T. With more subscribers because its an

iPhone!, and with more revenue per customer, the device yields AT&T a $100 monthly ARPU,much higher than the $50+ industry average.With this in mind, should we think of an exclusivity deal between Apple and a TVcarrier?Perhaps another AT&T deal, this time for their TV + Internet U-Verse line.AT&Ts network topology -- a dedicated set of wires running into each subscriber's home -- is ideal for voice and Internet traffic. But the company is at a disadvantage when itcomes to distributing several hundred TV channels, something a cable provider has no problemwith. Comcast simply taps into the coax cable that passes by each house and feeds the sameanonymous, multiplexed signal into the set-top box for authorization and decoding. (This is anoversimplification and ignores the evolving topologies made possible by opticalfiberbut werestill far from the dream of Fiber To The Home)iTV could give AT&T an opportunity to take the lead in 21st Century TV, to stopfightingComcast on its own ground. The resources AT&T deploys today to bring old-style TV channelsinto markets dominated by cable carriers could be re-allocated to the fast Internet access that

lets several iTV devices run in the same home. (Try asking todays friendly AT&T U-Versesalesperson how many DVRs you can have. One is the general answer, as this U-Verse



userdocument cautiously explains. Comcast will let you have -- and pay for -- as many as you like.)A simpler, more focused life, stealing subscribers from the incumbent, a higherPhone +Internet Access ARPU For AT&T, this could be a repeat of the original iPhone deal.Realistic?

I dont know if AT&T is bold enough to make such a move.For cable TV incumbents, the money pump equation is different. By virtue of theirdominant position, they have more to lose, they have these expensive, inflexible, and trickychannel bundles to protect. What looks like a potential ARPU uptick for AT&T could turn into asubscriber revenue decrease for a cable operator supplying Internet access to iTV viewersusing apps instead of channels.This gets us to iTV content. It will either be free, meaning subsidized by advertising; bysubscription, like Bloomberg BusinessWeek on a tablet; or pay-as-you-go, one sho

w or game ata time. One reader suggested wed end up paying more than we do with todays bundles. Its apossibility, but we might be happy to pay more in exchange for the freedom to pick and choose,as opposed to todays situation where adding an extraneous channel to an existing bundle isa chore that makes you feel like you work for the cable company and not the other way around.Who knows, we might even spend less overall -- while giving more money to the bettercreators.We now move to content providers. As they appify their channels, will they be willin

g togive Apple 30% of the app revenue? If the app is free, no problem: 30% of zero isntterriblyonerous. But even for a free channel, theres the question of sharing ad revenue:How much forCBS, how much for Apple? This isnt a random example, we just heard Lee Moonves, the CEOof CBS, say that his company turned down a streaming TV deal with Apple becauseof adisagreement over ad revenue. CBS and others have to see how iTV will make themmoremoney. (The same is true for game developers who could use iTV as a vehicle forliving roomor networked games.)Finally, Apple itself. Their emotive talk about the purity of the software architecture, the praisefor the elegant kerning of the Garamond Light Condensed ITC font on Keynote slidessuchtalk is important and relevant, it addresses the very reasons for Apples success,but weshouldnt forget what rings the Big Cash Register: hardware. The iTV product itself has togenerate billions in hardware revenue or stay what it is today, what Jobs felicitously called ahobby, a mere hundreds of millions of dollars of hardware revenue. Thats nothing

whencompared to the tens of billions -- soon $100B -- in iOS mobile devices revenue.How to get there? Recall last weeks No Set-Top Box configuration:



Ive added a twist, one simplification. Why have two devices, one iTV and one WifiBase Stationor Time Capsule? A unified device saves room, power, the need to have disk storage in twoplaces and it will help justify a unit price thats greater than the current $99 for Apple TV.

Lets put the price tag of this unified device at $299, the price of todays 2TB TimeCapsule. If Apple can sell 10 million units, thats $2.9B in revenue Not bad, but put thatnumber into the context of Apples overall revenue estimates: $120B in 2011 (calendar year,not fiscal), $160B in 2012, and $200B in 2013. $2.9B in iTV revenue doesnt get itout of thehobby category. Apple would need to sell 100 million units, $29B in revenue, toreally make adent in the universe.What about the revenue iTV will generate through the App Store as users buy apps

-aschannels? Consider iTunes: It made about $2B in revenue in the 2011 Fiscal Yearended lastSeptember (probably much less in profits as this is a complicated organization with manyrevenue streams and an expensive infrastructure). iTunes is hardly a loss leader, but itspurpose is to fuel iOS device sales, not the other way around. By analogy, the App Store andadvertising revenue share isnt going to make or break iTV.In last weeks Monday Note, I argued against an Apple-made big-screen TV: Too big,cant bebrought back to the store for repair, the computer inside would become obsolete

much morequickly than the screen itself.Friends tell me Im wrong. A Big Screen might be the answer to the revenue question. At$1,500 or more, an Apple HDTV set might achieve revenue levels in the tens of billions, and,unlike todays TV set industry, it might even be profitable.(As an aside: Last week, Sir Howard Springer, the courageous Welshman running Sony, let itbe known that while his company is -- like Apple -- in the process of re-inventingthe TV,Every TV set we make loses money. We also heard about Logitech giving up on GoogleTVafter losing tens of millions in the misadventure. And Adobe decided to stop Flash developmentfor TV. The news from the TV front could be better.)As a big beautiful flat-screen set, or even as a separate module, an iTV soundslike a greatidea. But translating the dream into a viable 21st Century TV product looks considerably moredifficult. To be successful, the iTV needs to make money for carriers, for content developers, fordistributors, and for Apple itself. None of which is self-evident.Still, the ossified TV ecosystem is ripe for disruption, ready for an annoying innovator.

[email protected]



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Monday Note #205 - Apples Antitrust Problem - iTV Wheres the Money

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