Neither pundits nor the general population in 2003 would ever have predicted just how strong of a year 2004 would be for Apple Computer. Having sold over four times as many iPods (4.4 million) as it sold in 2003 (939,000), say nothing of iTunes music sales and accessories, Apple did well over a billion dollars in iPod-related business in 2004 alone. Sales of Apple’s personal computers to PC “switchers” increased, and buoyed by strong media reports of Apple customer satisfaction and the mediocrity of its competitors, popular perception of the Apple brand decidedly shifted from “niche” to “worthwhile luxury.”
This was unquestionably a great year for Apple. With an iPod-focused perspective, iLounge now focuses on what went right and wrong in this year – and is likely to happen in 2005.
Defying Critics with Smart Moves
Coming off of a year in which the third-generation iPod built up considerable cachet and momentum for the iPod brand, Apple took a step in January which confounded still skeptical members of the media: it announced the iPod mini, which featured less storage capacity than any earlier iPod, yet at a price tag only $50 lower than its substantially more capable full-sized 15GB brother. Teased before the iPod mini’s launch with rumors of a $99 or $149 iPod, numerous people (including some at iLounge) wondered aloud whether a smaller but still pricey iPod was really what people needed.
The answer was a resounding and defiant yes. Even at a $249 retail price, the iPod mini sold out at literally every store where it appeared – for months – without any discounting. Younger buyers, females, and iPod newbies flocked to pick up the cell phone-sized 4GB unit in their choice of five colors; an international launch had to be delayed to meet American demand. Once released overseas, Japanese consumers lined up to purchase iPod minis despite decades of proven antipathy towards American electronics, as well as the established presence of global electronics juggernaut Sony. Even Apple was surprised by its good fortune – it couldn’t make enough to meet demand.
Apple similarly bucked trends with the release of the fourth-generation iPod in July. Without external hype or even a huge press event, the company debuted a redesigned white iPod with only modest improvements: aside from better (but not class-leading) battery life and the incorporation of the iPod mini’s simplified Click Wheel controller, the company was left to highlight minor software tweaks such as randomized song playback as key new features. A higher-capacity 60GB hard drive was rumored to appear in the 4G iPod line, but didn’t.
Paraphrased, the company’s message was strong: “you already love the features of our earlier iPods, and this one is a ‘best-of’ package.” Apple didn’t even radically change the iPods’ price points, as many had expected: iPod minis remained at $249, while $299 bought the lowest-capacity (20GB) 4G iPod and $399 the higher-capacity (40GB) model. The company’s quasi-price drops were achieved largely by dropping $100 worth of pack-ins that previously accompanied $399 and $499 3G iPods with the same storage capacities.
Competitors Aim for the iPod
By keeping so much of the iPod the same, Apple was saying that nothing significant in its design was broken or needed fixing. But competitors were emboldened by the company’s pause in innovation, and for the first time specified Apple by name as their target. Creative rushed a white, touch-sensitive version of its competing Zen player to market, and prepared colorful iPod mini challengers called Zen Micros for holiday release. Dell created a smaller (“Pocket”) version of its Digital Jukebox at the same physical side of the iPod mini, and Rio did the same with a bubbly alternative called the Carbon. All three companies touted better battery performance and capacity than the iPod mini, as well as extra functionality: microphones, support for additional music formats, and user-adjustable equalizer settings.
Then there was Sony, which awoke from an extended slumber to sloppily embrace the digital music revolution that had been underway for the past several years. Immediately before the release of the fourth-generation iPod, Sony introduced a hard disk-based 20GB Network Walkman intended to compete on price and functionality with Apple’s $399 iPod hardware. Boasting a smaller body and claiming both better battery performance and file compression than the third-generation iPod, the Network Walkman launched with both a competing music service and ad blitz hinting at Walkman-exclusive songs from Sony recording artists.
But the Network Walkman proved dead on arrival. Critics savaged Sony Connect, the company’s iTunes competitor, and Apple had the improved fourth-generation $299 20GB iPod in stores by the time the $399 Network Walkman showed up. Worse yet for Sony, it was revealed that the company’s storage capacity figures had been unrealistically fudged to appear better than the iPod’s, and that the Network Walkman couldn’t directly play MP3 or WMA files – which constitute the bulk of music used by consumers. Network Walkmen sat on store shelves, and half-hearted discounting began at around the same time as Sony promised replacement hardware.
Apple’s only other rival, Microsoft, tried a different tactic, developing software for a new portable media hardware standard that it believed would be popularized by partner companies iRiver, Samsung, and Creative. The “Windows XP Portable Media Centers” platform enables a single device to play back movies, music, and digital photographs, with price tags starting at $500. Though competing players were launched by these companies in Fall 2004, none rated more than a blip on the public’s radar. Apple executives launched an “it’s the music, stupid” public relations offensive, and thanks to Apple’s dominance of media mindshare and public opinion, Microsoft’s designs were ironically dismissed as impractical or too far ahead of their time for mainstream customers.
The Impact of the iTunes Music Store
One of the biggest barriers to entry for any iPod competitor is and will continue to be the iTunes Music Store, a completely and thoughtfully realized approach to selling digital content online. Without dwelling on the myriad innovations developed by Apple for the Music Store, it suffices to say that Apple has done nearly everything right with the service in 2004 – from interface tweaks to expanding its catalog of music and increasing the number of countries eligible to access it. Whereas major recording artists shunned digital distribution only a year ago, today many are willing to premiere their music on iTunes or sell it concurrently online with the physical sales of their new singles and albums.
This has only been enhanced by Apple’s recent and aggressive promotion of the rock band U2, building awareness for an album that subsequently hit number one internationally and nearly doubled the band’s top-selling chart entry domestically. After a half-decade of steady declines in off-the-shelf music sales, Apple has established itself as the closest thing to a potential savior as the music business has had – a promoter of individual artists that simultaneously can market and sell an entire industry’s creative output.
Even established music companies such as Sony, which went out of its way to involve Macy Gray and Aerosmith’s Steven Tyler in marketing campaigns for its own products, have come across as weak and out of touch with the marketplace by comparison. Non-music companies from Walmart to RealNetworks have tried other tactics with Apple, offering everything from aggressively discounted downloads to higher-quality and multi-hardware format compatible music. In every case – right or wrong – pundits have all but ignored these efforts and repeatedly endorsed the iTunes Music Store. And the only way to fully enjoy the iTunes Music Store, other than burning old-fashioned CDs, is to have an iPod: a double-win for Apple.
Apple’s single glaring iTunes weakness at the moment is its absence from populous and/or prestigious Asian territories, some because of overly aggressive (protectionist) public and/or private intellectual property concerns, others of which are due to under-aggressive regulatory and/or intellectual property regimes. While winning Japanese and Chinese market share requires two very different skill sets, it’s unquestionably the case that the iPod needs either or both in order to secure its place in history alongside the Walkman.
And iLounge remains convinced that Apple has the potential to turn another weakness – territorial divisions of music availability – into an unparalleled strength. Music fans for years have had to visit foreign countries or import “rare” albums from overseas because of “local exclusives” or the limited territorial marketing of a particular artist. Apple could achieve with the stroke of a pen and three mouse clicks what Tower Records and other bricks-and-mortar vendors tried unsuccessfully to achieve for years – a single storefront that sells an entire planet’s worth of music to customers anywhere on the globe.
Current nation-by-nation rollouts of the iTunes Music Store have seen quiet limitations in this area; the Canadian iTMS for example launched with a 700,000 song subset of the 1,000,000+ song American iTMS catalog, and there continue to be questions as to whether, say, American consumers will be able to buy all the music from the eventual Japanese iTunes Music Store. Apple could devastate its competitors by creating a universal store and guaranteeing foreign artists an even larger potential market for their music.
Winning over Partners: HP, Motorola, U2, SigmaTel
Though iPod sales were doing quite well on a comparative basis going into 2004, much of Apple’s recent brand super-strength came from a sense of inevitability: at some point, in the absence of any legitimate single competitor to the iPod, people began to assume that the digital music war was over and that Apple had won. While it’s impossible to put a single date on the shift in public opinion since it happened gradually, several critical partnering events in 2004 together turned the winds of public opinion strongly in Apple’s favor.
At the beginning of 2004, Apple competitor Hewlett-Packard announced that it had decided to join forces with Apple rather than compete against the company in the digital music market. Known for its numerous product releases and aggressive marketing, HP could unquestionably have launched a competitor to the iPod – and it even possessed a patent on one of the device’s underlying technologies. But when a company with the slogan “Invent” said it would clone rather than out-engineer the iPod, Apple received the best possible boost – one from truly unexpected quarters. Any suggestion that Apple needed to be the size of Dell, Sony, or Microsoft to compete in the marketplace was effectively quashed.
In mid-2004, Apple quietly announced a partnership with wireless phone maker Motorola to bring iTunes support to upcoming Motorola-branded cellular phones. The premise was simple: new Motorola phones will be able to play back AAC-encoded songs downloaded from Apple’s iTunes Music Store, a roundabout way of challenging the increasingly popular dedicated ringtone music business. Apple’s 99-cent-per-complete-song download option will indirectly compete against services offering stripped-down versions of songs for as much as $1.99 per download – indirectly in the sense that, for the moment, Apple can’t reach their customers unless said customers switch phones. A tie to the iPod brand alone might be enough to make people do that. If Apple developed a true hybrid iPod phone, who knows what might happen?
As previously noted, the company also formed an unexpected alliance with U2, a band that famously had rejected commercial uses of its music outside of traditional album, concert, and video venues. By partnering with such an established and perennially popular group, Apple not only raised its own credibility in the music business, but also held out two unique sales prospects. It created co-branded and unique iPods with splitting of royalties (the iPod U2 Special Edition), and invented the “digital box set” – an ultra-pricey but complete back-catalog of a band’s music. The message to other bands was crystal clear: even if you’re big and rich, Apple can make you even bigger and richer.
Finally, in late 2004, rumors began to swirl that Apple was planning to conquer the only remaining portion of the digital music market it didn’t yet control: solid state (“flash”) memory music players. Analysts reported that Apple had contracted with SigmaTel, provider of chips for numerous competing digital music devices, to use its tiny chip in an impending flash-based iPod product. If true, Apple’s deal with SigmaTel (after working for years with PortalPlayer and Wolfson Microelectronics, suppliers of chips used in both the iPod and iPod mini) would signal that Apple remains concerned about pricing, profitability, and rapid delivery of newer and smaller products to the low-end of the music player market, and did not believe that its existing partners had an equally attractive solution available. While there are pros and cons to broadening a company’s chain of suppliers, we tend to think that flexibility in this regard is a good thing for Apple (and consumers) at this point in time.
Missteps and the iPod photo
It came close, but 2004 was not a perfect year for Apple. For all of its achievements, Apple has had its small and infinitely debatable share of missteps and missed opportunities – the sorts of “problems” that history might ultimately judge otherwise.
Apple has traded on a certain public perception for years – that of the next-door neighbor whose house looked better than yours, but cost a lot more, and just occasionally put you off by reminding you of both of those facts. In a world full of people who are willing to accept second-best quality if the price is right, Apple’s products have historically waned in popularity every time a competitor came close enough at a lower price tag. And that competitor’s customers inevitably come to resent and dismiss Apple’s products as needlessly snooty and overpriced.
In the past, Apple has fed such negative perceptions by refusing to compete on the low-end on price, and by rejecting alliances with companies that might broaden the dissemination of its technologies at the possible (or likely) cost of direct Apple control of said technologies’ futures. Worse yet, like the rich neighbor who invites you over for dinner and then cancels either 20 minutes before or after the meal was supposed to start, Apple has occasionally entered into such alliances only to later recant and annul them.
This year, though Apple allied with Hewlett-Packard, it scoffed at a very public request from RealNetworks to ally on digitally downloadable music, compelling Real to forge ahead on a competing iPod-compatible download solution called Harmony. Though Apple successfully undercut Harmony in the court of public opinion by blasting it publicly and merely threatening to render iPods incompatible with it, the bigger issue is what value Apple might have added to the marketplace by partnering with Real against Microsoft and Sony. Turning away a willing ally – or worse yet, making them an enemy – isn’t ultimately in Apple’s or the iPod’s best interest. The only question we have is whether something more was going on behind the scenes that justified Apple’s initially brusque response.
Similarly, Apple took only a small step towards entering mass-market iPod sales with a product priced at the $250 mark. Traditional consumer electronics wisdom has it that certain price points are magic numbers for specific groups of consumers: a price tag of $399 or more for any new product guarantees that it’ll only be purchased by a small group of early adopters, while successive $50 and $100 slides down from that price level have the potential to radically expand demand for a decent product.
(For example, Sony noted earlier this year that 90% of the sales of the original PlayStation came only after it hit the $149.99 price point. Having started at a $299.99 price point in the United States and a ~$390 price point in Japan, it took Sony two and a half years and 12 million PlayStations sold to reach the $149.99 price point. The iPod just celebrated its third birthday. That Sony ultimately sold over 100 million PlayStations – 88 million at $149.99 or less – is very telling.)
The same price realities are likely to hold true for the iPod. Accessory makers already report “significant” differences in sales between products made for $299 and $399 iPods, and stocks of iPods in retail stores suggest that Apple’s manufacturing is skewed towards meeting greater demand for the lower-end, lower-priced iPod hardware. Given the cost of other Apple alternatives, it wouldn’t be surprising to learn that the iPod mini’s $249 price tag (rather than any of its other features) caused it to sell out within days of its release; it may be following a predictable supply/demand curve. But all told, even considering “sellouts”, Apple has still sold only six million iPods at this point – enough to create domination by perception, but not enough to preclude the entrance of other competitors. Sellouts are only important in an absolute sense when you have tons of product to sell.
That Apple has not lowered the price of the iPod mini is at least partially (and understandably) attributable to its inability to manufacture enough units to meet current demand. But instead of thinking in the single-digit millions, it is (and it was six months ago) time for Apple to start thinking in the double-digit millions in sales potential, and adjusting price and production accordingly. Even if there weren’t enough 4GB disk drives available back then, would people have balked at paying $199 for a 2GB iPod mini in the exact same casing? History suggests not – Apple probably could have sold two or three times as many of them as 4GB iPod minis, based on lower price, availability and pent-up demand. And would consumers jump all over a 1GB iPod-branded product priced at $149? History suggests so. Even though -we- can’t imagine going back to carrying only 250 songs at a time, there are plenty of people out there who haven’t joined the revolution yet.
On a final note, Apple succeeds in fighting negative popular perceptions every time it releases a breakthrough product design. Even though its G4 Cube didn’t sell so well (we’re inclined to blame pricing and public perception of limited software), Apple elicited drools and copycats from every corner of the PC marketplace with that product, and it still makes many computers that would tear apart the Windows world – if only they were cheaper. Nothing else explains the universal critical acclaim of products such as the iMac G5 and their inevitable failure to compare with the sales of generic black boxes from Dell.
The converse of this point is that Apple risks enhancing negative perceptions and emboldening its critics every time it releases a product design that isn’t a breakthrough but is still priced like one. iPods have generally been stunning, but Apple’s iPod accessories (from its dated $40 Remote control set to its $30 iPod mini Arm Bands and $30 iPod Socks) have been underwhelming for their respective prices. For a company that thrives on innovation, Apple more than occasionally turns potential customers off and stifles the growth of its user bases by choosing high-profit, low-sales pricing over lower-profit, higher-sales pricing.
It is in this context that we also remain a bit up in the air about the future of Apple’s iPod photo platform. On one hand, it is the highest-rated iPod we reviewed in 2004, and offers features (battery life, storage capacity, color screen) that we absolutely love. But at least in the period immediately following its introduction, it also has elicited scorn from serious photographers for failing to live up to its “photo” designation, proving less of a complete photo transfer, storage and display device than a colorful musical iPod that just happens to also display photos. While we don’t believe its price tags ($499, $599) to be objectionable, especially given that $499 purchased an eight-hour, black-and-white 30GB iPod from Apple at this time last year, we’ve heard a fair amount of criticism from those who think that the iPod photo is a half-baked response to the needs of photographers and the broader marketplace alike. Whether we agree or disagree, the negative perception is out there – to some extent – and it’s up to Apple to respond.
Concluding Words: Shutting Down the Haters
With that, we have come full circle: Apple entered the year with critics, and so it leaves the year with critics – the crucial difference being that there are now far fewer than before, and around four million new iPod owners, besides. Having defied expectations with the iPod mini and vaulted the iPod to new sales heights, partnerships and functionality with the 4G iPod, U2 iPod and iPod photo, Apple has clearly had a spectacular year, one far better than any of the doubters would have imagined.
Because there are still three key battles left to be fought – one for the flash player music marketplace, one to discourage Sony and Creative from remaining in the hard disk music marketplace, and one to win the upcoming battle with Microsoft, Sony, and other entrants over the next-generation (post-music) portable entertainment marketplace – we think 2005 will be remembered as a turning point for Apple. The company will inevitably be confronted by past and new foes, offerings of potentially important alliances, and numerous opportunities to change not just the music world as we know it, but go beyond that to take an international leadership role in more general-purpose home entertainment and consumer electronics. This could be the year when Apple moves towards selling 10 or 20 times its current installed iPod base. But it could also be the year when a competitor finally releases the Windows 95-caliber product that rips off just enough of the iPod’s syrup to sell like hotcakes.
iLounge would like nothing better than for Apple to reign supreme in 2005, but we think that pricing, innovation, and alliances will be at least as critical to such success as its competitors’ missteps. As we’ve done in 2004, we will continue to keep our eyes and ears on both Apple and its competitors, and look forward to your thoughts and comments on this year and the year to come. Jeremy Horwitz is Editor-in-Chief of iLounge. His recent book, Law School Insider, has been called the “best book about law school – ever,” and he continues to contribute to Ziff-Davis electronic entertainment magazines.