Wednesday, May 26, 2010

AAPL vs MSFT -what happened to best-of-breed?

During my time at the Kellogg School, I took a class on competitive strategy.  One of the quintessential strategy cases explored the battle between Apple and Microsoft for the computer market.  At the time, Apple had less then 3% of the market and the company was heading for obscurity, or worse.

Today, Apple's market cap passed that of its long time rival.  Twelve years ago the conventional wisdom held that the PC OEM model and the Wintel (Windows/Intel) platform allowed for a greater rate of innovation and a cost curve that Apple could never match.  In hindsight, this argument seems farcical.

At that time, strategy orthodoxy encouraged companies to specialize at the component level - chips, operating systems, applications, assembly - and that specialized best-of-breed vendors would outperform vertically integrated companies.   In fact, the idea of a company that produced both hardware and software was laughable and a strategy destined for a stale product line, bloated costs, and market share losses.

What happened and why was conventional wisdom so wrong?  The world of best-of-breed has been replaced by a world of vertical integration, whereby the frictions of assembling best-of-breed components are driving people to buy pre-integrated systems.  Oracle's acquisition of Sun is based on Jobs' vision of system level selling - hardware, software, peripherals.  Ellison argued that customers want to buy a a solution - not a set of components that are integrated by systems integrators to deliver value.  He argues, why not sell an pre-integrated solution, whereby each layer of the solution is designed to work best with the layer below and above it?

iPod/iTunes - software, computer, device, peripheral
iPad- App Store

Perhaps the insight is that as systems and "solutions" grew more complex - the incremental value of driving down marginal costs on a per component basis was overshadowed by the increase in marginal costs of assembling the components to solve the intended problem - ie listen to music, watch a movie, use an application.

Apple moved from competing on abstract utilities and generic cost per cpu to competing on systems designed to satisfy higher level consumer needs - consume media, produce media, share, network.... Integrated value not only supports much higher prices - compare a Dell laptop to a MacBook Pro - but also much higher level of consumer satisfaction.

Best of breed is dead - long live systems.

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