Apple Inc

Apple, IncCase 1

October 2, 2008BUSA 499Prepared by: FiNoMoDr. Chung-Shing Lee

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Table of Contents

I. Executive

Summary……………………………………………………………………………………………………………………3

II. Strategy

Identification……………………………………………………………………………………………………………..…4

Key Issues and Problems

III. Strategy

Evaluation…………………………………………………………………………………………………………………….4

Industry Analysis – Porter’s 5 Forces

Competitor Analysis – VRIO (Table 1)

IV. Strategic Option Development……………………………………..

………………………………………………………….9

Option A

Option B

V. Strategic Option

Evaluation………………………………………………………………………………………………………11

Trade-Offs Between Options (Table 2)

VI. Strategy

Selection……………………………………………………………………………………………………………………11

VII. Strategy Implementation………..

………………………………………………………………………………………………12

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I. Executive Summary

Apple Inc ignited the personal computer revolution in the 1970s with the Apple II and since then has been reinventing and innovating not only computers, but also other electronic goods. 1 According to the 2007 Annual Report, “the Company is committed to bringing the best personal computing, portable digital music and mobile communication experience to students, educators, creative professionals, businesses, government agencies, and consumers through its innovative hardware, software, peripherals, services, and Internet offerings.” Apple’s objective is to leverage its unique ability to design and develop its own operating system, hardware, application software, and services. The company wants to be sure that its customers are offered new products and solutions with superior ease-of-use, seamless integration, and innovative industrial design. Besides personal computers, Apple capitalizes on the convergence of the personal computer, digital consumer electronics and mobile communications by creating and refining innovations. Some of the most successful products and services offered are the iPod, iPhone, iTunes Store, and Apple TV. One of the company’s goals is to effectively reach more of its targeted customers and provide them with excellent customer service before, during, and after the sale.2

According to our research, we have specified that the main issue in the music entertainment industry is piracy. More specifically, it is the illegal download of music. A direct outcome of this issue is the iTunes program that was sold with every iPod. With iTunes, Apple was able to protect its music by encrypting each audio file to make it compatible only with Apple iPods. This prevented the music from being traded on illegal networks. 3

After detailed analysis of the Apple Inc, we have decided that to fight piracy, Apple has one of the following two options. First, it would have the option of increasing the DRM complexity (Option A) which would constantly require higher skills to update the system. The second alternative would be to remove DRM altogether (Option B) and allow users of players other than iPod to purchase the iTunes.

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We believe that Option B would be the best choice because after all it would allow not just the iPod users, but all users of any players to buy iTunes, which would be a great advantage to Apple.

By studying this case, we recommend for Apple to distribute DRM –free music. First, DRM does not solve piracy, but rather sustains it and creates opportunities for people to “break the code”. Second, if Apple abolishes the DRM protection, its competitive advantage would increase through greater customer satisfaction and loyalty. Next, DRM – free music would be more accessible to all consumers. And finally, since the music bought through iTunes is safe (e.g. free from viruses and corruption), users of all players would be rather encouraged to buy from iTunes.

II. Strategy Identification

The case gives wind of several issues in the industry. The most significant issue of all, regardless

of the other problem areas is the existence of music piracy. The outcomes of this are both the use of

Digital Rights Management (DRM) in the industry, and the industry itself. Legal digital downloads of

music emerged as a result of people downloading and sharing music online for free.

There also exist other key issues deducible from the case. First of all are hackers, who are able to

circumvent the DRM used by (e.g.) Apple in iTunes, requiring Apple to constantly upgrade the protection

on their digital music files4. Secondly, we have competitors, such as RealNetworks, who were sued by

Apple for making their software compatible with their own, in an attempt to channel sales to their

software, Harmony5. Finally, an emerging trend in the music industry, unmentioned in the case, is that of

self-sufficiency among established artists. Nine Inch Nails6 and Radiohead7, for example, are both

operating outside of the control of a record label and releasing and selling music on their own, even

going as far as to giving it away for free8. This may suggest a shift in control from record labels to artists.

III. Strategy Evaluation

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Porter’s Five Forces:

Threat of Entry

How entry works in the industry of music entertainment, specifically, the online music stores, is

interesting. Basically, there is not great cost advantage to the existing companies because it is not

expensive to create an online music store; the basic factor needed is the knowledge to create it.

Economies of scale, which explain that a firm’s costs fall as a function of its volume of production, are

not true for the online music industry.9 This is so because the music store owners have to obtain the

records that they would like from the record companies and then pay the record companies a royalty for

every song sold through their online store.

Product differentiation as barrier to entry is quite low because there is not much that can be

done to differentiate music – it is already different in itself. One of the most common options would be

the add-ons or extra options that come with the music sold.

Cost advantages independent of scale as barriers to entry is also very low. Compared with a

pharmaceutical industry for example, where it takes decades to accumulate experience, not much

experience or technology is required to sell music online. There are also almost no government

regulation as a barrier to entry.

The Threat of Rivalry

The threat of rivalry within an industry is determined by four factors. The first is the presence of

a large number of firms of a similar size. While the number of competitors within the entertainment

industry is numerous, Apple’s control of the market (assuming they can sustain it) lowers the level of

threat in this respect. The second factor is the slow level of industry growth. The entertainment industry

is expected to grow fast10, meaning that the level of threat posed by rivalry remains low in this respect.

Companies have, however, tried often to gain market share by going head-on against their competitors

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(a trait attributed to slow industry growth), meaning that the situation is not as black and white as

theory might suggest. Thirdly, the threat of rivalry tends to be high when there is a lack of product

differentiation. This is true for the entertainment industry, in which the services provided are very

similar. Companies compete with various pricing strategies, including iTunes’ 99 cents per song

download and Napster-To-Go’s monthly fee of $12.50 for unlimited access to songs11. The fourth and

final factor that increases rivalry in an industry is the abundant addition of production capacity. This,

however, does not apply to the entertainment industry12.

1 Apple Inc Website. Support Centerhttp://www.apple.com/investor/2 Securities and Exchange Commission. 2007 Form 10-K for Apple Inc.http://www.sec.gov/Archives/edgar/data/320193/000104746907009340/a2181030z10-k.htm#toc_de19701_2

3 Barney, Jay B and Hesterly, William S (2008). Strategic Management and Competitive Advantage. Pearson PrenticeHall. p. PC 1-11


5 Ibid. p. PC 1-12

6 Moulds, Josephine (October 2007). Nine Inch Nails Follows Radiohead and Dumps Label. Telegraph.co.uk. Retrieved October 1, 2008, from http://www.telegraph.co.uk/finance/markets/2817362/Nine-Inch-Nails-follows-Radiohead-and-dumps-label.html

7 Radiohead’s ”In Rainbows”: Track-by-Track Preview (October 2007). Rolling Stone. Retrieved October 1, 2008, from http://www.rollingstone.com/news/story/16654550/radioheads_in_rainbows_trackbytrack_preview .

8 Ibid. Fans could choose from a variety of package options for the album, including a digital download for which consumers could choose to pay what they wished, including nothing.

9 Barney, Jay B and Hesterly, William S (2008). Strategic Management and Competitive Advantage. Pearson PrenticeHall. p. 41

10 The Global Entertainment Industry is Expected to Show an Annual Growth of 10% in the Next Four Years and That Growth Will be Driven by China (August 2007). BNET Business Network. Retrieved October 1, 2008, from http://findarticles.com/p/articles/mi_m0EIN/is_2007_August_20/ai_n19452832


12 Ibid. pp. 46 - 47

http://www.apple.com/investor/

http://www.sec.gov/Archives/edgar/data/320193/000104746907009340/a2181030z10-k.htm#toc_de19701_2

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Threat of Buyers

This threat is extremely large. There are a large number of customers which are all very price

sensitive. It is easy for the buyer to switch to another product. The buyer’s final decision lies in actually

purchasing the product with constraints such as the DRM systems or not. If the buyer do not have an

Apple product, they are not likely to buy the product the way things are at the moment. This also

increases the threat.

The Threat of Suppliers

Suppliers in the entertainment industry can be classified both as the recording artists and/or

songwriters as well as record labels. The recording industry consists of a number of firms, including

many small, independent labels (making up 12.61% of the industry’s sales) and a few large companies

known as the “big four”. These are, classified by size – largest to smallest: Universal, with a market share

of 31.61%; Sony BMG, with a 27.44% market share; Warner, with 18.14%, and EMI, with 10.2%13.

Companies in the industry are quite numerous, meaning that entertainment industry firms have a lot of

choice in where to source music. However, the major contenders in the recording industry are very few

and have a lot of bargaining power in terms of regulations, as well as the price and availability of the

supply of their products. Just recently, the National Music Publishers Association announced their desire

to increase the royalty paid by Apple per downloaded song from 9 to 14 cents, costing the company an

additional $144 million. Apple’s response was a threat to close iTunes altogether, demonstrating the

sway of suppliers over companies in the entertainment industry14. Music, as a product, is very unique,

meaning that companies in the entertainment industry will have a hard time challenging suppliers, and

finding alternative ones. Apple, however, has a very strong lead in the industry due to the popularity of

13 Cashmere, Paul (January 2007). Universal The Biggest Label of 2006. Undercover.com.au. Retrieved October 1, 2008, from http://www.undercover.com.au/News-Story.aspx?id=1215.

14 Ramsay, J.T. (October 2008). Apple Threatens to Close iTunes. Comcast.net Music. Retrieved October 1, 2008, from http://www.comcast.net/music/blindedbythehype/2855/applethreatenstocloseitunes/

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iTunes and its linked consumer electronics product, the iPod, lowering this aspect of threat from

suppliers, to an extent. Thirdly, the high threat of substitutes outside of music (DVDs, movies, etc.)

serves to lower the threat of suppliers. Finally, the threat from upward vertical integration remains low.

The case shows that iTunes is force to be reckoned with in the entertainment industry by sheer

popularity. This is further confirmed competitors’ futile attempts to take control15, 16.

Because of the aforementioned rise in self-sufficiency among certain artists, the threat of

suppliers from the songwriter/artist side has become far more pressing. Artists who value DRM-free

digital music files may opt out of supporting industry giants demanding that music have such encryption.

Self-sufficiency also means that the suppliers may set, not only the price of the product, but also its

supply; once again, due to the uniqueness of the music as a product, companies in the entertainment

industry have few choices to turn to if these suppliers decide not to work with them. In the increased

self-sufficiency of artists releasing music on their own, we may already see a form of forward vertical

integration. In terms of substitutes, artists (at present) do not have to worry about the format that their

music is released. If, however, the popularity of digital media over the traditional hard copy formats

(CDs, vinyls, etc.) becomes far greater, artists not supported by an entertainment industry firm will be

negatively impacted. In its current state, the threat of substitutes for the artists as suppliers is low,

increasing threat from suppliers in the entertainment industry. If the aforementioned potential situation

arises, the threat of suppliers may be grossly lowered17,18.

It will be interesting to see how far the self-sufficient artists’ control will extend. To look at an extreme

scenario, there is a chance that we may see companies in the entertainment industry working with

15 Barney, Jay B and Hesterly, William S (2008). Strategic Management and Competitive Advantage. Pearson PrenticeHall. pp. PC 1-6 to 1-13

16 Ibid. pp. 47 - 49

17 Ibid. pp. PC 1-6 to 1-13

18 Ibid. pp. 47 - 49

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artists as the suppliers rather than record labels. Doing so would create a positive image of supporting

musicians for Apple, potentially furthering their popularity. On the other hand, while removing some

problems (to the short-term benefit of artists and consumers), it may be creating an entirely new one.

The repercussion of such a move could be a war among entertainment industry giants for artists to be

“signed” to digital music providers, effectively shifting the battleground from one industry to another

and creating all new threats of rivalry and suppliers.

The Threat of Substitutes

The threat of substitutes is huge. There are several major substitutes such as illegal

downloading, buying CDs in a regular record store, download music to your cell phone, and buying

music videos. (DVD concerts) These are almost perfect substitutes because it serves the same purpose,

making music available to you when you want to listen to it. There are also other substitutes like going

to a concert, listen to the radio, watching TV, watch a movie, or simply go to a restaurant where they

play background music. The availability of music makes the threat major.

Apple’s growth in the past several years shows as evidence that if done right, selling music

online can be a very profitable business. One of the components consumers use in deciding where to

get their music is whether the music files are protected with DRM or not. Currently, all music that

Apples sells on iTunes is DRM protected.19 We see that Apple positioned itself well in the music

entertainment industry and for the time being, needs to sustain its’ position. In the future, however, as

piracy increases and DRM secrets will continue to leak out, Apple would do better by repositioning to

the DRM-free music.

Table 1: VRIO Analysis

Resources and Capabilities

V R I O Competitive Advantage


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Brand/Name √ √ √ √ Sustained

Logistics √ X X √ Parity

Design/Product √ X X √ Parity

Innovation √ √ √ √ Sustained

DRM √ X X XNo Competitive

Advantage

Customer Loyalty √ √ √ √ Sustained

The VRIO analysis shows that Apple’s competitive advantage is mostly achieved through its

brand, innovation, and customer loyalty, as well as combinations of the three. The Apple and iTunes

brands are both well respected and trusted by consumers. Apple’s innovation with the iTunes/iPod

combination is another important factor; an innovative product, combined with a user-friendly, all-

encompassing service covering both a means to keep and organize music on one’s computer as well as

to purchase new music easily (i.e. through e-logistics) . Finally, through their innovation and name, as

well as the clever combination of hardware and integrated software, Apple has been able to create a

competitive advantage for itself through customer loyalty.

Logistics (i.e. the means by which consumers are able to purchase music directly onto their

computers), while innovation, is neither a rare, nor inimitable resource or capability for Apple. For

similar reasons, the design of iTunes as a product bestows them only with competitive parity, rather

than sustained competitive advantage. DRM, on the other end of the scale can be seen as valuable to

Apple and the music industry to the extent to which it works (until someone hacks it), however, as is

shown by the case, is not a rare capability, is highly imitable, and is not organized in a way that would

provide sustainable mitigation of the problems it is trying to solve20.

20 Ibid. pp. 76 - 92

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IV. Strategic Option Development

There are several strategic options the company can implement to solve the key issue. One

course of action could be Apple continuing their current course hoping that hackers will not be able

to crack the DRM systems that are already in place. They fix it with small updates in the iTunes

software. However, our team has provided two mutually exclusive courses of action that we will

base this paper on:

Option A

The first course of action is to increase the complexity of the current DRM systems. The case

suggests that already in 2005, hackers had cracked the DRM system and written software allowing the

files the iTunes store to be shared freely.21 Since they already have been cracked several times, the

encryptions have to be made a lot more complex. If not, the whole point of having a DRM system

disappears. Unfortunately, history has shown that even the most complex encryptions can be cracked.

One example is the DVD. It was supposed to be impossible to crack the code, but it was cracked within

weeks of release. Piracy is hindered only until next hack is made.

Option B

The second course of action is to remove the DRM system completely.22iTunes are required by the

record companies to have DRM systems on all the files they sell. However, if iTunes sell 2 billion songs

from their online store, the record companies themselves sell ten times this amount. The funny part is

that the record companies themselves sell all of their songs without DRM systems on the songs.

Research tells us that the average mp3 player can hold approximately 1000 songs, but only 3% of the

21 Barney, Jay B and Hesterly, William S (2008). Strategic Management and Competitive Advantage. Pearson PrenticeHall. pp. PC 1-6 to 1-13

22 Thoughts on Music, Steve Jobs, February 6, 2007

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songs are protected with DRM systems. When this is the case, why even bother having them in place?

Removing the DRM system would also make the songs available to customers who don’t own an Apple

product.

Interestingly enough, a 2007 study conducted by the University of London at the request of the

Canadian government showed that illegal downloads of music did not affect the legal music purchases.

In fact, owing to the increased exposure gained from allowing illegal downloading to happen, artists’

could see an increase in their record sales23.

V. Strategic Option Evaluation

Table 2: Trade-offs of Options A and B

Option A Option B

Cost x √

Time x √

Quality (Customer Satisfaction) x √

Choice x √

23 Moses, Asher (November 2007). Piracy Not Raiding CD Sales. The Sydney Morning Herald (online issue).

Retrieved October 1, 2008 from http://www.smh.com.au/news/web/piracy-not-raiding-cd-sales/2007/11/06/1194118008817.html

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X = bad √ = good

Obviously, Table 2: Trade-offs of Options A and B show that Option B is the better option of the two.

First, the cost to implement a more complex system would require more resources which would have to

constantly be improving. However, without DRM security, there would be no cost at all. Second, The

time that it takes a consumer to find the record that they want would decrease without DRM security

which would also be more convenient since it will all be in one place (at iTunes). Customer satisfaction

would greatly increase without the DRM because consumers would be able to buy music that is not just

playable on iPods, but also on their computer and other mp3 players. In the end of course, consumers

would have more choices and opportunities to control the music they own.

VI. Strategy Selection

First of all, since the DRM systems are a requirement from the record companies, Apple has to

convince them that having the DRM systems is not preventing piracy. Apple then has to drop the DRM

systems on their music files. They key to succeed after dropping the DRM system is to launch a huge

marketing campaign letting people know about the removal. It should be clear to the public that they

can now use the music files purchased from iTunes on any device. This will hopefully put pressure on the

record companies as well to drop the systems.

Secondly, DRM-free versions of the songs should be uploaded free of charge for the customers that

have already purchased DRM protected songs. They now have to upload the remaining library.

The main thing here is to market the DRM-free songs to the public. This is to make sure the

consumer knows the songs will work on any application when they purchase from the iTunes online

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store. As long as Apple can convince the record companies to shut down the DRM systems,

implementing it should not create big problems.

VII. Strategy Implementation

DRM systems cause more problems than it fixes. There are always people who are willing to put the

time and effort to crack the encryptions. Keeping the encryptions up to date is time consuming and

costly as they always have to be one step ahead of the hackers.

Removing the DRM systems is also another example of how to increase customer satisfaction. The

consumer can now play the songs he purchased on any application he might chose. This leads to a

competitive advantage through better customer loyalty.

Removing the DRM systems also makes the music more accessible to consumers. Many consumers

are not purchasing songs online because of these constraints. They seek other sources instead, including

illegal downloading. Considering that iTunes is the biggest online music store on the market, removing

the DRM systems should increase their market share significantly. People will be encouraged to buy

music off iTunes rather than download it illegally thanks to the safety of using iTunes over free

downloads. You get high quality files rather than getting viruses and corrupt files.

ENDNOTES

Documents

Apple Inc