Economics for Business
The company that I am studying is Apple. The company is a designer and marketer of consumer electronics, specifically computers, smartphones, tablets, mp3 players and software. The company has experienced a strong run of great performance in recent years, but it has not always been that way for Apple. The company struggled considerably, especially in the 1990s, before breaking loose. The key thing about Apple is that it has always sought to differentiate itself. Over the course of the past ten years, we have seen most of Apple's former competitors in the personal computer space leave the industry. The reason is that the computer industry is moving towards the strategic hell of perfect competition.
The term strategic hell reflects the condition of perfect competition. In the real world outside of economics textbooks, few markets can be truly understood to be perfectly competitive. Perhaps a vegetable market in a developing country, where everybody in the village knows what it takes to grow a head of lettuce, so they have perfect information, and nobody has any means of differentiating their lettuce. This example is extreme, and in most markets today the worst that can happen is that they can approach the conditions of perfect competition.
Perfect competition is strategy hell because businesses cannot turn a profit in a perfectly competitive market (Tutor2U.net, 2013). The products are not differentiated, there is no size difference between suppliers and consumers have perfect information, which means that producers sell at marginal cost in the long run. There may be an opportunity for profit in the short run, depending on the cost curve of the company. However, this is a very difficult type of market in which to operate, where turning a profit requires either collusion from the different suppliers to ensure the price is at a profitable level, or an unspoken social contract that the price paid will be higher than marginal cost in order to allow the sellers to survive -- why people buying in the market accept prices higher than marginal cost.
In order to break out of strategy hell, a firm needs to eliminate the conditions of the perfect market. Our lettuce vendors at the market might seek to brand their stalls, or provide other products, as a means of earning profit. For computer makers, the situation was actually quite similar. Windows was the dominant platform, there were only a couple of serious chipmakers in the world, and many of the other key inputs into computers were becoming commoditized. The writing was on the wall for the industry, especially as consumers were starting to learn more about their machines. The computer industry was moving increasingly towards conditions of perfect competition. Strategic hell. While nobody expected it to become a perfectly competitive market, the closer the computer business go to that condition, the tighter the margins became. Apple has already been differentiating itself with proprietary design and especially with proprietary software and operating system, but its response went further than that.
The following chart illustrates the lack of profitability inherent in strategy hell:
As Riley (2013) notes there are different ways to turn a profit under conditions of perfect competition. The first is to lower costs, so that average cost is below the margin cost. This gives the opportunity to price at marginal cost and still turn a profit. This is not, however, the approach that Apple took. The company instead took the opposite approach.. The low cost approach is one that is difficult to sustain in the long run, for a few reasons. First, the low cost approach relies on there being something less than perfect competition because in theory all firms are the same size and should have the same capacity to lower their costs, and consumers have perfect information. Second, the low cost approach is hard to sustain in a global marketplace where there is always a lower source for the good. This is why it is called strategy hell, because it is almost impossible to turn a profit and yet there is very little management can do to change the situation.
However, the other way to get out of strategy hell is to differentiate. This effectively takes the market out of a state of perfect competition, because firms compete on a variety of factors. This is a state of monopolistic competition. The competition is intense, but the monopoly element comes when...
Apple differentiates in a lot of different ways to ensure that it does not enter strategy hell
The first way that Apple differentiates is through diversification. Apple launched the iPod and iTunes and in that way began to build a business outside of computers. This provided another revenue stream for the company, meaning that even if computers entered into a state very close to perfect competition the company would still be able to earn profits.
The second way Apple got out of strategic hell is through branding. Mourdoukoutas (2013) notes that Apple pays a lot of attention to branding, because it recognizes that a brand is a means by which consumers will be convinced to pay more. With Apple, brand association is key, and the company made a point to create brand associations that had value. In this way, Apple convinced consumers that they were not just buying a computer, they were buying a Mac. That additional value allows them to earn monopoly rents, because some consumers are unwilling to consider other options.
A third major point of differentiation at Apple is with the products themselves. When Apple was trying to succeed in a computer market that was moving towards perfect competition, it wanted to do so with a differentiated product. Apple has its own operating system and software, and it has a focus on design that other computer makers lack. The result is that Apple has a differentiated product. It expended a lot of energy trying to avoid ending up in strategy hell, because it knows that the further it gets from strategy hell, the more profitable it will be. A quick look at the income statement and balance sheet for Apple indicates that their differentiation and financial success have both been substantial (MSN Moneycentral, 2013).
What is interesting about Apple's approach is that it specifically avoided attempts to compete on cost. The company realized early on that commodity electronics will typically be sold at just over marginal cost, which is a point that is barely profitable in recognition of the fact that the product is barely differentiated. For Apple, it knew that inputs would still be commodity, and key inputs would almost assuredly be available to competitors as well. Its products use many of the same underlying technology as its competitors' products. The key to success for Apple is that it has found a way, through external design and through software, to take a generally undifferentiated core technology and make it a truly differentiated product.
The question remains as to how well Apple has insulated itself from the problems associated with strategy hell. For example, its vulnerability to external shocks must be considered. The company's vulnerability to supply-related shocks is actually not much different than that of its main competitors like Samsung, since they rely on the same suppliers. However, Apple has also done an excellent job of protecting itself against other shocks. For example, the company has a strong focus on innovation, because it knows that demand and price elasticity of demand with respect to consumer electronics are not affected by prevailing economic circumstances. The company' recent exceptional financial performance corresponds with the economic downturn starting in 2008, but also coincides with the launches of the iPhone (in 2007) and iPad (2009). Thus, Apple knows that innovation is a great hedge against external shocks, and the company's business cycle at this point is almost entirely dependent on the state of its technological innovations.
Market exposure is another consideration. Apple is not immune to changes in its key markets. The company has, in particular, been driven by mobile products in recent years. That market is highly competitive with the different Android products, and that market is also in a state of rapid change. Competition from Android has dramatically reduced Apple's market share, something that has not hurt the company yet because the industry was growing so rapidly, but which may come to hurt the company later. The following charts shows the worldwide smartphone market by operating system.
Source: Lunden, 2013
In this industry, Apple enjoys supernormal profit but many competitors do not. Google makes no money directly from Android, which skews the market. Blackberry is not making money at all. Of the companies that sell phones, Apple has most of the profits, Samsung has the remainder and every other firm in the industry is believed to be losing money…
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