vertical integration of design and post-pcs

9 Apr

The news that Apple has been building an RF/baseband team is a great reminder about how cool vertical integration of intellectual property design can be as design and final manufacturing continue to fracture.

I wasn’t a business strategy wonk growing up, I was too busy writing software, so my first view of vertical integration in manufacturing, contract manufacturing and white-label manufacturing came during the mid- and late-90’s at Microsoft while working with PC OEM’s on the troubling issue of “low-cost consumer PCs.” OEM’s were in a price war that was driving their margins into the dirt and were giving Microsoft (the $70 Windows software license) and Intel/AMD (the $50 CPU price) grief over those parts of their cost as well as trying to figure out how to differentiate their products. We were helping key OEMs prototype different special-purpose uses for the Windows operating system which could be sold with new high-volume consumer products under a lower licensing cost to hit the <$300 retail price point. (This effort and some of our prototyping was one contributor to the initial XBox.) I was fascinated to learn details about how much PC OEM’s had outsourced manufacturing (and some forms of the hard intellectual property design) to foreign white-label manufacturers. Some small players had literally outsourced everything but their logo, their sales staff, and their direct-mailing lists. It was clear even then that they were not differentiable and fully doomed. Others, like Dell, were still doing final customer-specific options assembly and industrial/mechanical (particularly pluggable component) design but were no longer designing much of their printed circuit boards (PCBs). The more I learned the more this seemed like a difficult-to-defend position without unique software capabilities to differentiate the clearly commodity hardware. PC OEM’s had no brand-exclusive content.

One PC OEM that stood out and then led me down the rabbit hole of game consoles was Sony, who I learned was an extremely vertically oriented company – at one point it probably built the trucks that dug the sand and copper to be carried by its ships to its factories to be turned into glass and magnets for TV tubes to be carried again by its ships to markets around the world. Sony’s vertical integration experience in many different CE devices from Walkman to CD players to stereos to TVs taught it how to manufacture Playstation One consoles cheaply and then to radically reduce their build costs each year over the life of the console. It was using this technique in PCs and notebooks as well, delivering the most appealing and smallest PCs and commanding the highest margins for a time (though the PC OEM war of specs and hundreds of configurations dilute and defeat many of these advantages). Studying Sony’s’ Playstation and PC/notebook businesses as well as their various content business illuminated two important things for me which may seem at odds, but they are not: (1) vertical integration of hardware intellectual property is critical for differentiation, though the actual manufacturing can be carefully out-sourced if possible, and (2) Software differentiation (content) is the even more important differentiator. Ironically for Sony, it was the fact that even the strongest advantages of their vertical integration and their deep investment in hardware intellectual property for consoles wasn’t enough to keep ahead of the price-performance trajectory of commodity PC CPUs and GPUs. (It’s good to see them embracing the PC ecosystem and focusing on exclusive content now.)

Which brings me back to Apple, who clearly learned more lessons than everybody else combined from the PC OEM wars. Lessons about how differentiation matters, how intellectual property design must keep its distance as far as possible from manufacturing, and most importantly how to prevent a cross-over threat from another ecosystem.

In the classic PC/notebook space, Macs continue to use many off-the-shelf PC parts (ethernet chips, CPUs from Intel, memory), but their deep investment in industrial design and consumer-important features like thinness, lightness, screens and longevity require expertise and investment in the intellectual property of PCBs, glass, mechanics, aluminum, manufacturing, just to name a few. They use the intellectual property of hardware design to make their products unique and their exclusive software clinches the deal, allowing them to keep their margins high.

More interesting still, though, is the mobile, Post-PC or “Internet Of Things” space. Here with iOS and ARM-based in-house-designed CPUS Apple’s overall vertical integration strategy is just shockingly impenetrable for the foreseeable future. Post-PCs will be small, highly-capable, full of sensors, network-connected, power-sipping, and accessible to developers. Apple’s environment is all this, and is particularly strong in low-power. At this point Apple just lacks dedicated in-house designers of displays, touch-screens and batteries, though they appear to have long-term investments and future capacity contracts with their key suppliers and manufacturers. They don’t actually own the team which designs the graphics processor (Imagination Technologies, creators of the PowerVR GPU) though there is evidence of a deep investment & long-term contract. I suspect there must be a right-of-first-refusal or right-of-first-purchase in place. (I still don’t understand why Imagination hasn’t been bought by somebody, they are an amazing company who understand low-power better than just about anybody).

Android plus off-the-shelf hardware from the non-Apple ecosystem of ARM CPUs, GPUs and baseband controllers are nearly price-competitive, but already at the cost of very slim margins for all the intermediaries (increasingly for the medium- and high-end, this is just Qualcomm). Apple building custom baseband chips will mean Apple has fewer intermediaries and so pays less (it would likely pay $20-30 less per device using in-house baseband, or 10% less of its fully-loaded bill of material), and I’m guessing they will continue to outperform on power-consumption. Qualcomm will feel pressure from OEMs to further reduce prices and power-consumption, leading to lower margins and less ability to invest long-term. This is the aspect of the strategy which prevents an ecosystem cross-over – living in the same ecosystem as your competitors, retaining exclusive content, as in PCs and notebooks, but being able to do cutting edge intellectual property investment in literally every component with no exceptions. By bringing the hard intellectual property design of the very same ecosystem in-house and securing inexpensive manufacturing there simply is no competitive price-performance curve for competitor to cross over.

I shake my head at the genius of not just managing your supply chain but literally eating every bit of intellectual property designed within it except the lowest margin manufacturing. I see no offensive strategy capable of cracking Apple’s Post-PC lead at this time. Perhaps (I hope not) anti-trust will eventually be used, but it’s really more a waiting game for Apple to stumble and slow their pace of innovation.

9 Responses to “vertical integration of design and post-pcs”

  1. Richard April 9, 2014 at 10:32 pm #

    Do you see the only effective and/or realistic strategy to mirror and match the Apple gameplan?

    • natbro April 10, 2014 at 8:55 am #

      still thinking on this subject, but briefly
      * no, i don’t think it’s possible for anybody to exactly match the strategy doing IP design all the way down the stack as deeply as Apple does. there’s nobody with enough hardware+software DNA or the right business model.
      * Apple has weakness in cloud services and identity generally. Must-have competitive features which require deep server infrastructure and identity are hard for them. Maps proves there is a weakness but also proves that it needs to be a bigger & harder feature to actually shift the balance.
      * you would expect the many competitors in hardware and software would be able to out-innovate one player trying to do everything, but Android, Blackberry, Windows etc competitors have been playing catch-up on small-potatoes features against one another for the most part and aren’t signaling any sort of holistic plan or attempt to leap-frog Apple. it seems to me this is happening because the overall market is growing so much that the focus is naturally on how to cheaply capture and retain newly entering cheaply. later as the market size begins to peak, and if the innovation slows, the competition will toughen and shift to stealing share; that’s when it will get intense, or at least this is how it played out in the PC space and that is so far a good analogy.
      * it will take one or several dedicated competitors to put together the large investments needed to build a leap-frog product that can unseat the Big Fruit.

    • April 10, 2014 at 7:19 pm #

      Well PC OEMs play a different game from the beginning of their existence
      so they can’t with there 5% margin.
      If Intel and Microsoft try they will get flack from their OEMs.
      Even Apple has the ability to leave Intel.
      Microsoft has not had a hit software product in the last 10 years.
      So No innovation from the richest monopoly with fattest war chest.
      Even Intel has been pushed by Apple to innovate and Apple
      has asked the most from intel to bring new products.
      List is long.

      Google could get good enough crowd with ad driven pc experience
      with ChromeOS. That is best you can hope for
      because Web was basically designed to get freedom
      from Microsoft but in the process basically damaged
      itself to effectivity compete with Apps.

      So if you want to escape from Apple’s orbit you will
      be doing the same thing people did to get away from Microsoft.
      Even with commoditization of hardware and software a lot
      of money is needed to have quality hardware and software
      that is the secret of Apple.

  2. Dr.No April 10, 2014 at 7:07 pm #

    Well with latest iphone 5s/ipad air, the GPU is listed as Apple GPU
    not Imagination.
    Apple has hired team of AMD engineers in Florida.

    Apple purchased Nortel patents.

    The reason Imagination hasn’t been bought because Intel and Apple
    equal parts of the company and probably have first bid clause or something
    to that effect.

    A7 costs $18 or less while LTE Chips costs upward $40.

    How else will Apple compete with cheaper phones.

    • natbro April 10, 2014 at 7:18 pm #

      the A7(x) chips in the iPad Air and iPhone 5s do say “Apple GPU” but it is an Imagination Technologies PowerVR G6430 – they just “white-label” it.
      I agree with you – I’m guessing at some point the long-term contracts by Intel, Apple and Qualcomm expire and Imagination is picked up by somebody – I’d guess Apple.
      One way of thinking of it is “how else will Apple compete with cheaper phones” – another way of thinking of it is “how do you make sure your competitors don’t have high margins so they can’t compete long-term.”

      • Dr.No April 10, 2014 at 7:47 pm #

        Apple and Intel each own 10% of imagination so it not a matter
        of contracts.
        Apple just signed another agreement with Imagination
        in February which probably has clause for custom GPU cores.
        Apple also gets H264 encoder and may even get ISP block
        from Imagination. No one really knows, it is just my guess.

        Apple could have purchases Infineon instead they
        let Intel buy it but
        Apple were too busy fighting FRAND patent suits
        so they went with Qualcomm just fend that
        off because qualcomm already had liscense from everybody and get CDMA chips at the same time.
        But now this reason has disappeared and CDMA is effectively dead.

        Also Qualcomm seems to give discounts
        to those that buy combined SOC and LTE chip
        in one package.

        So Apple can integrate within their SOC to have
        additional power savings.

  3. WaltFrench April 10, 2014 at 7:10 pm #

    I guess Qualcomm has a pretty decent business; ARM, too, and Intel for sure.

    But most of the other companies in this space are struggling to keep decent margins, margins that Apple takes for granted. That means that the customers of those chips have low prices, and while they may not always have leading-edge capabilities they’re never far behind. Just read a review of the Galaxy S5, for example: exactly nothing wrong with the technology in terms of power, capability.

    So Apple concentrating its efforts on in-house production gets even more “fragile” in that their products depend even more on tight coordination of everything working right. Maybe that’s the reality of computing over the next decade, but it flies in the face of the Received Wisdom from the Disruptive Technology types, who see commoditization ruling as the markets mature.

    Maybe on-the-phone voice recognition and beacons everywhere and who knows what other tech will indeed soak up all the extra processing that Apple is seemingly aiming for. But if not, they are just producing an ever-more-expensive device when pretty good would be quite good indeed.

    And at the same time, many of us are looking for a much stronger push in services and more connectivity with the 80% of the world that’s not on iOS. But Dropbox, Google, Microsoft and Facebook are the ones making the headlines. Maybe Apple’s hardware position is secure enough that they can let Microsoft do all the iSync stuff as a service, but certainly if it’s Google that’s leading, Apple shouldn’t expect a level playing field.

  4. WaltFrench September 1, 2015 at 5:13 pm #

    “I still don’t understand why Imagination hasn’t been bought by somebody, they are an amazing company who understand low-power better than just about anybody.”

    Imagine Intel bought them out. Then Apple would create a competitor. Even if they couldn’t do as well. A lot of other companies the see themselves as Intel competitors would look to alternatives.

    Imagination would be paying for all its first-class talent with a small fraction of its current customer list. It’d be a bad deal for any hardware customer to buy them, as they’d have to pay for the whole company, but only get a fraction of the benefit.

    Apple—and likely, Intel, too—get what they need from their deals with Imagination.

    • natbro September 1, 2015 at 6:47 pm #

      I have long wondered about this and asked around several times. I have heard various combinations of (a) Imagination was asking too much and/or at some point asked too much and pissed Apple off, (b) the company cultures just aren’t a fit, so Apple just does very long-term contracts and retains a right to the complete IP in situations of acquisition, making life good for Imagination and poisons acquisitions for others, (c) some tension about Imagination also licensing to Android, but then again Apple seems to get the latest IP exclusively early.
      I’m inclined to believe it’s mostly about fit, it really is an odd one.

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