As the world’s first trillion-dollar public company, Apple is no stranger to the public spotlight. Not all of this attention is positive, however. Critics blast the company for a variety of reasons: supposed antitrust violations, controversial design choices, and struggling iPhone sales, to name a few. Despite these headwinds, Apple’s market capitalization continues to hover at an all-time high. Apple’s position as the world’s most valuable company becomes even more surprising when one considers the fact that Apple does not actually hold a dominant share in any of its main product markets. Its unit share of the personal computer market is less than 10%, while Lenovo and HP each control over 20%. In the global smartphone market, it lags behind both Samsung and Huawei in unit share.
Given its less-than-dominant share of these product markets, how is it that Apple has achieved its record-setting market capitalization? The answer lies in the firm’s dominance of a key space: the product ecosystem. Through this hidden source of value, Apple ties together its various products and maintains high demand in spite of stiff competition. It capitalizes on this fact by charging a significant price premium over competitors. Going forward, the company’s performance will largely depend on how well it can maintain this advantage in the unforgiving, ever-shifting landscape of the tech sector.
The economics behind product ecosystems are fairly straightforward but create powerful effects. The products within an ecosystem interact together in a synergistic way, such that the value of the ecosystem is greater than the sum of its constituent products. As a result of these interactions, a product is more valuable to a user if that user already owns one or more products in the ecosystem. Once customers enter the ecosystem, there is a strong incentive to buy more products to reap additional synergies between them. The most powerful product ecosystems also draw upon network effects, the additional value created by having more users in the ecosystem. If a customer’s products positively interact with another user’s products, both individuals benefit and the value of the ecosystem increases.
To leave an ecosystem, customers face switching costs equivalent to the value provided by the product being replaced and the beneficial interactions it had with other products and customers. Customers will only leave if the value provided by the replacement product exceeds the switching cost. The more synergy between products, the greater the switching costs and the harder it is to leave. As a result, consumers become locked in to an ecosystem as they buy more of its constituent products and face higher switching costs. This effect helps companies like Apple create inelastic demand, in which customers demand similar quantities of a good even at higher prices. The company can then capitalize on this lower sensitivity to price changes by charging price premiums in otherwise-competitive markets.
There is, however, an important caveat: customers considering their first product do not yet reap the benefits of product synergies within that ecosystem. Because they own no other products to create synergies with, customers considering joining an ecosystem or having only just entered one do not initially derive much added value from joining. Thus, their demand is relatively elastic (price-sensitive) at this point, making them more likely to choose comparable substitutes. There is also the endowment effect at play, in which customers tend to ascribe less value to a product they do not yet own. In this case, prospective customers may not realize the extent of the benefits to be gained from joining the ecosystem. While the benefits derived from interactions with other customers in the ecosystem can counteract these difficulties, fledgling ecosystems lack the user bases necessary to create these network effects.
A company seeking to establish a product ecosystem must find other ways to reel customers in. A firm can offer cheaper, entry-level products or bundle multiple products to be sold as one. Strategies like these help get customers past the initial hurdle of joining the ecosystem. As soon as customers enter the ecosystem, the new goal involves raising switching costs and deterring customers from going back to competitors. However, a company must be careful not to lock in customers before proving the added value joining the ecosystem will provide them. If customers recognize that the future switching cost associated with locking in to one company’s products is too high, they will not be swayed by lower current prices.
The implementation of these product networks therefore involves a delicate balancing act: companies must convince customers of the benefits of locking in to an ecosystem and simultaneously limit access to alternatives. Walking this line is the most difficult—and most crucial—when first creating a product ecosystem. The Apple ecosystem started many years after the company’s inception as a personal computer manufacturer. Apple’s first steps toward the eventual creation of a product ecosystem came with the pairing of the Apple II computer and the “killer app”, VisiCalc, which first came to market in 1979. As the first spreadsheet application for personal computers, VisiCalc was extremely useful to businesses; its dependence on the Apple II to run meant demand for VisiCalc would feed demand for the Apple II. However, this was a primitive ecosystem, as customers faced very low switching costs once other machines were able to run VisiCalc or similar programs like Microsoft Excel, launched in 1985. While Apple sold many Apple II computers thanks to VisiCalc, this ecosystem precursor could not yet convince customers to “lock in” to Apple products in the presence of comparable alternatives.
To establish a truly powerful ecosystem, Apple had to coordinate two formidable tasks. It needed to offer products that revolutionized their respective markets; it also had to get them to work together in a way that would bring customers in and make them stay. It was only in 2001, when Apple entered into the music player market with its first iPod, that customers actually faced a meaningful choice of whether to lock in to a multi-product ecosystem. Apple’s fledgling ecosystem came with some serious trade-offs. The company’s online music store, iTunes, was first accessible only to Mac users, and its accompanying Fairplay software prevented users from engaging in the prevalent practice of illegal music sharing.
To get customers to lock in to this new system of buying and playing music, Apple’s ecosystem had to offer considerable advantages over competitors that could make up for these restrictions. Apple ensured that its iTunes and iPod products worked together in a way competing products could not easily imitate. The process of downloading music was made simple by coupling the two; users could easily sync music from iTunes to their iPods and access that music through a straightforward interface. Unlike with the Apple II and VisiCalc, these advantages did not depend solely on explicit exclusion of competitors. Even when iTunes support expanded to include Windows computers, the Apple ecosystem lived on due to the cohesion between the iPod and iTunes store.
Only 18 years after the release of the iPod, Apple’s ecosystem now spans smartphones, laptops, tablets, wearables, television, and even electronic payment services. On their own, Apple products attract users with their form factor and ease-of-use, but the synergies between them are the standout feature. Software services like AirDrop and iMessage allow users to reap additional benefits from owning both Apple computers and phones, while also creating network effects as the number of Mac and iPhone users rises. As Apple continues to increase both the size of its user base and the scope of its product lines, it will have more opportunities to create synergies between them and increase the value provided to those in the Apple ecosystem. It is no accident that this will also increase switching costs.
Apple further locks in users through the integration of its hardware and operating systems; Apple devices operate on proprietary software like MacOS and iOS by default. This is a valuable advantage in the hardware space, where products are mainly differentiated by the trade-off between price and performance. Price-to-performance is only part of the story for software demand, which depends greatly upon individual preference for design choices like user interface. By coupling hardware with proprietary software, Apple does more than just improve platform stability; it differentiates its hardware and thus decreases price sensitivity for its smartphones, tablets, and computers. Even as competitors offer devices with similar or even superior hardware—more reliable keyboards being a prime example—users’ familiarity with Apple operating systems can make it a daunting prospect to move from an Apple device to a competitor.
This does not mean that Apple is immune to competition; both competing products and rival ecosystems threaten to pull customers out of the Apple product network. Apple currently offers a relatively small product line, designed to appeal to a broad audience while keeping production costs down. Many companies have seized on this characteristic, creating products that cater to specific subsets of Apple’s general customer base. Google’s Pixel 4 smartphone offers higher resolution and refresh rates than the iPhone 11, while Dell’s Alienware subsidiary vastly outperforms the MacBook line in gaming. With this strategy, Apple’s competitors can carve out niche markets for themselves and attract customers with certain traits like price sensitivity or strong preferences for specifications like camera quality or graphics performance.
There are still several issues with this “death by a thousand cuts” strategy of challenging the Apple ecosystem. Since a few major players dominate the operating system market, most of these niche products differentiate themselves through hardware performance. Because customers are relatively price sensitive towards hardware performance, these firms are highly vulnerable to competitors offering comparable products at lower prices. Furthermore, niche appeal naturally sets an upper limit on the size of a firm’s market share; there are only so many hardcore gamers or avid photographers to attract. Firms specializing in one type of product also become more vulnerable to changes within their niche market. Failure to keep up with a new technology or shifting consumers tastes can devastate a firm without diversified product lines to fall back on.
Companies can also attempt to create opposing ecosystems to usurp Apple’s. Google’s mobile operating system, Android, offers an alternative to Apple’s iOS. Google also bundles its Google Mobile Services with Android devices, often pre-installing its own applications like Gmail, Google Chrome, and YouTube. Notably, Android is actually the backbone of an “open ecosystem”, in which other manufacturers can run Android on their devices without licensing the software from Google. Due in large part to the advantages of this open-source design, Android devices make up a larger market share compared to iOS devices. As Google still earns licensing fees from the Android name itself and bundled Google Mobile Services, it has benefitted from allowing other companies to populate its product ecosystem and has increased the overall number of users in the process.
The success of Android shows it is possible to peel customers away from an existing network of products, but the dynamics of switching ecosystem make it difficult for firms to do so. A customer will only switch ecosystems if the cost of switching is lower than the gain realized by joining the new ecosystem. Because technology products are often expensive, customers are unlikely to simultaneously switch all of their products to those provided by another company. Instead, consumers tend to buy technology products periodically, often replacing existing ones as they near their end of their usable lifespans. Varying upgrade cycles across devices make it difficult to coordinate a multi-product move to a new ecosystem.
The alternative, one-at-a-time approach carries its own set of drawbacks. When switching a device to one in a different ecosystem, users lose a lot of synergy from the old device, and as discussed earlier, gain very little synergy from the first product in the new network. Thus, the initial switch between ecosystems also represents the highest switching cost. Google overcame this in the case of Android, bundling its applications with the operating system to make it easier for consumers to become immediate multi-product users within its ecosystem. As a substitute to iOS, Android also carries unique advantages that appeal to a large number of users, not just a niche market. This mass appeal ensured that enough Android users would switch to also create advantageous network effects. As a result of its bundling strategy and Android’s standalone value, Google overcame the significant hurdle of initiating a rival ecosystem.
Google’s success with Android also exemplifies the primary risk facing Apple’s ecosystem: Big Tech competitors. Each of these firms draws on established brand recognition and a massive user base to make headway in adjacent industries. While Big Tech firms like Google, Amazon, Facebook, and Apple ostensibly dominate different product markets, the scope of their operations means they overlap and compete in a variety of industries under the umbrella of the technology sector. The Amazon Fire Stick vies with Apple TV, Google and Facebook are both making forays into virtual reality devices, and even Facebook and Amazon compete in advertising. Each company leverages its primary products as sources of synergy, intending for new devices and services to be used in conjunction with existing products, rather than in isolation. The widespread popularity of these firms’ main products helps push users past the initial, single-product sticking point of forming ecosystems.Despite these many sources of competition, the Apple ecosystem will not be issuing its death rattle anytime soon. The critiques levelled against the company are largely overblown, and investor sentiment seems to agree. Apple’s slowing smartphone sales are mainly a result of market saturation. Charges of anticompetitive practices are directed at Apple’s Big Tech competitors just as often. Apple customers continually demonstrate remarkable levels of brand loyalty with products like the iPhone. Apple’s expansive ecosystem is still a powerful asset, but it alone cannot sustain Apple’s lofty valuation forever. Apple will ultimately need to rely on the key ingredient that allowed it to establish its ecosystem in the first place: innovation. Apple users committed to the company’s products because they offered features and usability unmatched by the competition. If Apple does not continue to offer new, cutting-edge products to keep customers locked in, customers will ultimately migrate to ecosystems cultivated by competitors.
I am a second-year student at USC, majoring in Economics-Mathematics. On this blog, I will share my take on the technology issues the world currently faces.