Theory of Disruption – Integrated Players and Modular Players

I’ve been singularly impressed by the level of technology industry analysis available on the internet, through blogs, podcasts and twitter these days…

Ben Thompson at Stratechery and Exponent.fmBenedict EvansHorace Dediu at Asymco… And there are several good writers at Techpinions… All of it makes for much better reading and a lot smarter, more insightful ideas and discussion than what you can find by going to TechCrunch or any of the traditional “tech news” websites sites… so much for the new media revolution…

Anyways, in particular, podcast discussions are very fascinating, for the main reason that you can see the actual formulation of a concept of theory… You can go behind the scenes of the finished article, and really see the nuts and bolts around how someone goes from Point A to Point B… and the twists, turns, discussions, arguments and blood, sweat and tears involved in crafting a well reasoned, articulate, concise and clear point.

On the latest Exponent podcast, the discussion topic was integrated vs modular players, and the pros and cons of disruption theory as it was articulated by Clay Christensen in the 90’s. Or, what we’ll call “Classical Disruption Theory“.

While the podcast is extremely interesting, there simply was something that I always feel is missing in these discussions… the discussion beyond just “integrated” and “modular” at the hardware and software level, but to really look at the entire stack… and really, really get in deep at where the value is generated (rather than where the value is captured) in the entire value chain… from blocks of aluminium to making a phone call or uploading a photo to iCloud…

#1 – The Value Chain (simple)

Value Chain

One of the interesting things about the big technology companies in the mobile space – Apple, Google, Microsoft, Xiaomi – is that they all capture value in different ways…

– Apple captures it’s value by selling hardware, with nice, big margins (30-40%)

– Google primarily makes it’s money through advertising… everything else (hardware and software) simply provide reach and distribution

– Microsoft makes it’s money through licensing and subscriptions

– Xiaomi makes it’s money through value added services

Now, inherently, if you have a very similar business model to one of these big players, but have no real differentiation that gives you a sustainable advantage, you become simply dominated…. One of the interesting things about having DIFFERENT primary business models, however, is that it can give you an area where you are asymmetrically BETTER in at least one area, than your competitors…

At the end of the day, Samsung really doesn’t have any unique core strengths where it adds value, that will not ultimately (with enough time) be copied by other companies lower down the chain… Samsung DID have a unique advantage, being both the manufacturer and systems integrator, to be able to experiment with all sorts of different device configurations… Samsung does need to be credited with blazing the trail for large screen smartphones 5 inches and above… But getting somewhere FIRST doesn’t necessarily give you a SUSTAINABLE advantage… While Samsung dumped BILLIONS into their Galaxy brand with marketing and advertising, the fact that top tier Galaxy smartphones dropped close to 50% in a single quarter year over year, shows just how much value “brand” can have in the technology space, where the basis of competition is on innovation, innovation, innovation.

Blackberry had a fantastic brand, and they even had fantastic phones, for a time. No one cares anymore… So no, brand recognition is nice, but it’s not something that gives you a strong foundation to work with.

#2 – “Software” vs “Hardware”

While in Ben and Jame’s discussion on Exponent, they had a very clear discussion around semantics between the differences between integration and modularization of hardware between assembly and design, vs manufacturing…. I feel like the exact same mistake is being made (without being called out) when we talk about “software” as one giant category… Especially when one of the core fundamentals is that the context being discussed is one of user experience.

A key part of the user experience, on the software side, is the services and application layers in the value chain.

After all, what is Apple Pay? Sure, on the back end, it’s likely a very complicated layer of software and API’s communicating to bring you a simple and easy payment experience. But at the end of the day, what IS that payment experience, if not a service that is being provided to customers?

And how much of that service, fundamentally, requires non-software related talents and skills?

When talking about Apple Pay, not only is it the low level software and integration with NFC which makes Apple Pay “work” in real life… But it’s also all of the partnerships that Ben talks about in his podcast, and in his posts… It’s the partnerships with the banks…

To make the iPhone a product which is a reality, it’s not just the hardware and the software… it was the partnership with the carriers, with AT&T which made everything different.

And for iTunes, it’s the work that goes into signing all of those partnerships with record labels… to actually provide the MUSIC by which iTunes provides an easy purchasing experience….

And at the end of the day, it is really these front end services which customers see, experience and can enjoy… which define a large portion of the usage and ownership experience…

Who else has stores, where if you have a problem with your device, you can take it in and get help? Or get lessons on how to use your device more effectively? Or who has stores, which makes walking in and buying a new device, a simple, easy and fun experience??

These ARE services… they are definitely part of the total ownership experience of owning an Apple device, and a great part of the “stickiness” of buying an Apple device, but in many of these cases, they have NOTHING to do with software… They might be technologically enabled? They might use software? They might incorporate hardware? But Apple’s ability to deliver an entire customer friendly experience to owning and using their devices, goes beyond just the simplistic software/hardware integration vs modular debate.

Yes, there are other companies, like Google or Microsoft, who all offer “services” powered through software and technology… Google Now… Search… Office… and even Google has partnerships with media companies for Google Play store content…

But who else fundamentally goes way, way, way beyond just the hardware and software, and partners with hundred’s of banks to make Apple Pay “work” the way a normal person would expect it to work?

Who – before Apple – had the leverage to partner with a carrier… Who else has the ability to build

#3 – “Services” – the third wheel

Value Chain - Partnerships

So, perhaps we should alter our diagram to add a 3rd component…

I really would like to hear more and more people talk about this NON software and NON technological component when talking about the entire ownership experience of buying, using and owning a particular device.

And when it comes to defensibility… or when it comes to questions like “what can samsung do”… you almost have to talk about the services layer on top of the OS layer…

Samsung doesn’t own anything close to this part of the value chain. Xiaomi is looking to build out their services layer and monetize it, but how do they do that in a sustainable way outside of China? Sure, they can make partnerships with regional service providers… Russia perhaps, or India if they have strong, localized service providers…. But I think it is a huge, huge mistake to not talk about services when talking about integration vs modular…

It needs to be hardware and software and services together… and as time goes on and on and on, and more and more innovation and value capture is either in the service layer entirely (Xiaomi) or in the integration of all three layers (Apple Pay) you need to talk about it.

#4 – Stock Price – the one hit wonder

And while I don’t want to go chance down a rabbit hole, this is also why Wall Street and the stock market (and likely many analysts) do not fundamentally understand what Apple is…

People think of Apple as a product, hits-based company… They think of Apple like the iPhone, or the iPad or the Mac businesses…

This is fundamentally wrong… Wrong, wrong, wrong.. The common saying is that Apple is just one bad product away from completely going to zero. This is insane.

You can be forgiven for perhaps making this mistake, but this is a causality of how Apple makes money (through hardware)…. but this does NOT make Apple a hardware company!

In fact, as Ben pointed out in his podcast, Apple doesn’t even OWN the majority of the factories that actually produce the raw materials to make chips, to make phone cases, to make batteries… Those are likely not high margin businesses, and by not owning those factors of production, Apple takes advantage of the BENEFITS of a modular approach, while still – through controlling the design and acquisitions process – gets the benefits of having an integrated strategy.

So just becomes Apple makes the vast, vast majority of it’s revenue and profit from selling hardware, this does NOT make Apple a hardware company! And in fact, when you look at the core things which Apple owns, the big pieces of the value chain (such as designing their own silicon etc…) or the things which Apple has the ability to influence (partnerships with banks, carriers, music labels) or the eco-systems which it controls (eg. their iOS platform, where thousands of developers build on top of things like iCloud, CloudKit, HealthKit etc…) in reality, Apple as a company has a HUGE, huge competitive and strategic advantage over competitors.

So yes, Apple SELLS hardware and YES they make their money primarily capturing value at the retail level, Apple as a company is actually far more than a hardware company, and where Apple’s real advantages lie, are in areas that are very difficult for competitors like Samsung to be able copy…

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