December 20, 2012 7:54 pm

Apple: Innovator’s dilemma

The company has been consistently creative in hardware and software – but can it find its way through the cloud?
Apple CEO Tim Cook©Getty

In the dark? Tim Cook, Apple chief executive, admits the cloud takes his company outside its comfort zone

Maybe it’s just the “4 per cent curse”. In February Apple became one of an elite group of companies whose market capitalisation grew so large that it made up 4 per cent of the combined value of the entire S&P 500. Its share price peaked on September 19 at $702.10, from which point – like Microsoft, General Electric, Cisco and other 4 percenters before it – it fell 25 per cent.

This is partly the law of large numbers: achieving such a great valuation triggers limits for some fund investors. And, after appreciating by more than 70 per cent, many shareholders – perhaps fearing new US taxes on dividends and capital gains – simply decided to enjoy their profits.

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But for Apple sceptics, the swinging stock-price chart had a different meaning: that Apple has peaked.

Some investors are starting to wonder whether Apple’s brilliant second act – the period of innovation that delivered the iPod, iPhone and iPad and made it the world’s most valuable company – is coming to an end.

Fourteen months since the death of its founder Steve Jobs, Apple finds itself in a changed technological landscape. Rivals such as Samsung and Google are catching up in the smartphone and tablet businesses it pioneered. And the internet and services in the “cloud” – whether web-based applications such as maps and messaging or the ability to synchronise content from one device to another wirelessly – are becoming just as important as shiny hardware.

At similar junctures in the past, Apple has simply produced another blockbuster device. But the opportunities to reinvent new products such as phones or personal computers are becoming harder to identify. A television set, seen as the most likely innovation to emerge from Apple’s Cupertino headquarters next year, is expected to cost $1,500, not the $400 of an iPad or the $99 consumers can pay to get an iPhone – making it harder to imagine as a mass-market product.

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The iPhone is expected to bring in revenues of $80bn this year, with another $30bn or more from the iPad, making it harder for Apple to come up with new products big enough to make a difference. In the meantime, Wall Street is struggling to understand how much further the existing products can grow. China and Latin America, the next big untapped mobile-device markets, offer thinner profits and tougher competition.

The most wounding criticism levelled against Apple is that its innovation has become incremental – its latest iPhones and iPads looking little different to their predecessors. That puts pressure on Apple’s accompanying services to dazzle and differentiate from its many copycats. The App Store and iTunes are thriving, still far ahead of their competitors.

As its leadership in hardware has come under pressure, Apple has found itself having to learn the rules of a new game. Its business still revolves around drawing customers to stores to buy its latest must-have gadget. But online services are increasingly important in keeping customers loyal, acting as the “glue” that moves personal information and media between a family of devices and helping to set Apple’s portfolio apart.

In the cloud, Apple is operating outside its comfort zone – something chief executive Tim Cook acknowledged when he apologised for its flawed Maps app in September.

Jobs foresaw the importance of a cloud services ecosystem as a way to defend against cheaper competitors. In 2010, when visibly ill, he launched iCloud, declaring it “our next big insight”.

“We are going to demote the PC and the Mac to be just a device,” he said, “and we are going to move the digital hub into the cloud.”

The idea was that Apple’s cloud would allow iPhone owners to float their music and apps on to an iPad, then a TV and back again.

Aware of the inroads made by Google, Microsoft and Amazon, Jobs impressed the urgency of the transition to becoming a cloud-services company on his biographer, Walter Isaacson. “We need to be the company that manages your relationship with the cloud,” he said.

Apple’s share-price peak on September 19 happens to have coincided with the release of iOS 6, the update to its iPhone operating system that replaced the popular Google Maps with an inferior mapping application of its own.

While Apple’s products have progressed into the cloud, its corporate organisation has not adapted. Cloud-based services, such as maps and Siri, the iPhone’s virtual assistant, require constant tweaks and improvements at the back-end. But until this autumn, these tasks were overseen by Apple’s software division, which is accustomed to big-bang annual updates, such as iOS 6. The perfectionist private testing and pixel-level tuning that Apple gives to a piece of software before releasing it requires a very different design and development process to more iterative, feedback-based services such as Maps. Yet it took two years after iCloud was launched for Mr Cook to make the necessary changes to Apple’s management structures in Cupertino.

A shake-up in October led to the departure of Scott Forstall, Apple’s software chief. Power shifted towards Sir Jonathan Ive, the British designer credited with creating the unique look of Apple’s hardware. And responsibilities for Maps and Siri were handed to Eddy Cue, who runs the iTunes and App Store units.

The exit of Mr Forstall, who joined Apple when Mr Jobs returned in the late 1990s, is a big loss to the company, say those who worked for him. Even those who rankled at his aggressive management style say that in many ways he was the closest Apple had to Mr Jobs’ product leadership.

Yet Mr Forstall clashed with Sir Jonathan, who now has responsibility for the look and feel of software in addition to his hardware role. Relationships that held together under Mr Jobs frayed under Mr Cook.

“Those guys really didn’t like each other,” says a former senior manager. “Steve kept everyone in line but without Steve it got worse and became very counterproductive. Credit to Tim that he recognised this.”

Mr Cook also recognised – belatedly – that just as Apple’s best products blend hardware, software and services, so too must its teams. He told Bloomberg Businessweek he had made the changes to ensure Apple was a “fast-moving, agile company where there are no politics, no agendas ... These moves take collaboration to a whole different level.”

Appointing Sir Jonathan to lead design in what one former staffer calls a “very pixel-driven” engineering culture shows that Mr Cook recognises he is a “numbers guy”, not someone with the feel for products of his predecessor. “One of the challenges facing Apple is that if [Mr Cook] is the brains, where does the soul come from?” another former employee says.

Tony Fadell, who led Apple’s iPod division until 2008, says Mr Cook is a “really smart, brilliant guy”, but that until last year “he was always behind the scenes”. “Steve had a track record of innovation that allowed him to draw in people when he had something new,” Mr Fadell says. In recent media appearances Mr Cook has made greater moves into the spotlight but he lacks his predecessor’s magnetism.

Defenders of Mr Cook’s product nous point to the huge range of new devices that Apple launched this autumn, with near simultaneous redesigns of the iPhone, iPad and iMac.

“This year has been an intense year on products,” Mr Cook told Time magazine. “Like no other.”

A much discussed idea – a premium-quality Apple TV set – could provide a new leg of growth. Mr Cook hinted to NBC that the TV market was now “an area of intense interest” instead of a mere “hobby”. After a visit to Asia, Jefferies analyst Peter Misek reported “several prototypes floating around” that were controlled by gestures and voice recognition. It could launch next autumn. “We think it’s vital that it comes,” Mr Misek said. “It’s a key linchpin in the home. We think it would act as an ecosystem halo effect.”

Apple’s App Store and iTunes are vital parts of this ecosystem. One app-market researcher, Distimo, estimates that on a typical day, consumer spending on the App Store is $15m, more than four times as much as Google Play, its marketplace for Android devices – despite the iPhone’s much smaller share of the handset market. The money spent by Apple customers on apps makes it less likely that they will switch to Android, where iPhone apps are incompatible.

But the App Store’s success rests in selling third-party software, much of which is now available on Google and Amazon’s platforms. Beyond the core operating system, Apple’s own apps and services are less successful; Ping, Apple’s attempt at social networking within iTunes, was quietly but ignominiously shut down in September. Other parts of Apple’s cloud suite, such as iMessage, the free text-messaging service built into iOS, and Game Center, Apple’s social-gaming hub, are prone to bouts of downtime.

. . .

Some analysts say these issues are merely symptomatic of Apple’s rapid growth and can be fixed with sufficient time, investment and server capacity. “These do not require the application of magic,” says Horace Dediu of Asymco, contrasting it with the innovation needed to conjure new smartphones and tablets.

But the concern is more acute because of the obvious advantage that Google, which was born online, has in cloud services. Patrick Gibson, an independent app developer and former iPad engineer, touched a nerve among Apple watchers with a blog post observation that Google was moving faster. “Google is getting better at design faster than Apple is getting better at web services,” he wrote.

Next year, the well-oiled Apple hype machine will crank up again to prepare the way for its latest “revolutionary” product, be it a new phone, tablet or TV. Yet after the stratospheric success of the past decade, Apple is looking for new superlatives that can excite Wall Street as well as the high street. Carrying its reputation for perfectionism into the new era of services will not be easy.

“Most companies are good at one thing. Apple is good at two – hardware and software – and that made it the world’s most valuable company,” says a senior Apple employee who left this year. “But it’s struggling with getting good at the third.”

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