Apple is unquestionably the most admired company in the world today. So what is Apple’s defining capability?

Lest there be any doubt, they told us last summer: Apple is about design. It’s what they value, teach, and celebrate, and it’s what has enabled them to revolutionize industry after industry with innovative products and business models. 

Design as the New Management Tool

Largely due to Apple’s unprecedented success, design has recently become extremely fashionable in the broader business imagination:

A selection of recent headlines

Business gurus like Roger Martin, institutes like Stanford’s d.school, and consultancies like IDEO have all helped spread the gospel. With the worthy aim of making design accessible to the rest of us, they’ve broken down “design thinking” into step-by-step frameworks, which generally involve empathetic understanding, creative ideation, and experimental prototyping.

We saw this pattern with the Lean and Quality movements too - both generated extensive, organized, and widely adopted disciplines (think of Six Sigma’s DMAIC methodology and hierarchy of belt colors). But I fear that “design” has moved too quickly to the tools and techniques stage - the “how,” instead of the “what.” It’s quite evident that even Apple’s close competitors have not come anywhere close to replicating its design capabilities. And the reason is that many companies are missing the forest for the trees.

What Design Is Really About

Putting aside all the trappings associated with them, the big management ideas described above can be whittled down to first principles. The core object of the Lean philosophy is waste. Quality is fundamentally about variability. And design is about intent.

Intent means purpose; something highly designed was crafted with intention in every creative decision. Frank Lloyd Wright explained that intent drives design with the credo “form follows function“; P&G calls this being “purpose-built.” The designer is the person who answers the question “How should it be?”

Overarching intent is easy. The hard part is driving that conscious decision-making throughout every little choice in the creative process. Good designers have a clear sense of the overall purpose of their creation; great designers can say, “This is why we made that decision” about a thousand details.

Which is exactly what Apple does. Their obsession with intentional choice is palpable and personal. When Jony Ive, Apple’s newly titled SVP of Design, criticizes a material selection or feature decision, “he’s known to use ‘arbitrary’ as a term of abuse.” Steve Jobs himself couldn’t even make the most mundane personal design decisions without deep consideration of intent; according to his biographer, this led to a longtime lack of ample furniture in his home:

“We spoke about furniture in theory for eight years,” recalled [wife Laurene] Powell. “We spent a lot of time asking ourselves, ‘What is the purpose of a sofa?’”

The Three Design Evasions

The opposite of design, then, is the failure to develop and employ intent in making creative decisions. This doesn’t sound hard, but, astonishingly, no other leading tech company makes intentional design choices like Apple. Instead, they all commit at least one of what I term the Three Design Evasions:

The first evasion: Preserving

The easiest way to avoid a decision is to not ask the question in the first place. Anyone who’s ever led a business project knows the temptation of recycling precedent – why reinvent the wheel? That’s why, for all of Microsoft’s recent design plaudits, the Surface still features a 30-year-old vestigial key. That’s also why BlackBerry’s last-ditch effort at mobile relevance, the Q10, has a physical keyboard yet again.

But great designers know that sacred cows must always be evaluated for slaughter. Apple is famed for aggressively making clean breaks with the past; you can decry any one decision, but to Apple, nothing is ever settled for good. As Christa Mrgan astutely observed in Macworld, “Sentimentality doesn’t make for good design.”

The second evasion: Copying

Copying others’ design choices is the most obvious way to abdicate forming your own intent and having to make decisions yourself. That didn’t stop Google from fundamentally redesigning Android after the iPhone was unveiled. Nor did it stop HTC from replicating the iPhone’s UI features or colors. Most shameless of all, of course, is Samsung, whose list of appropriated products, features, and even strategies is so long that one suspects the tendency is deeply entrenched in the company’s culture.

Without a doubt, Apple has copied certain features from its rivals as well. The difference is that Apple seems biased to design based on its own intent first, and copy second; its rivals tend to copy first.

The third evasion: Delegating

Delegating is by far the most subtle, pernicious, and widespread of the three evasions, particularly among tech companies. Under the guise of being “user-driven” or providing “choice,” delegators leave crucial design decisions up to the user. One can even subdivide this tactic into three distinct flavors:

A) Offering a wide range of product choice

Many of the most successful hardware companies seem incapable of deciding how their products should be, so instead they offer variety:

• Take Samsung again, which offers over a hundred distinct smartphones and tablets; this “spray and pray” strategy is the norm, not the exception, in mobile devices.
• Google is taking this a step further, developing a modular smartphone that would “allow” consumers to separately purchase and swap components in and out.
• Of course, PC makers like Lenovo, HP, and Dell have long epitomized choice, each offering a bewildering array of configurations.
• On the software side, Microsoft couldn’t choose whether to prioritize legacy functionality or mobile optimization, so it offers both Windows 8 in “Pro” tablets or the more limited Windows RT.

The banner of “choice” is always good PR, and may even be good product strategy for many companies. But it’s not design. Design means curating the choice for the consumer. John Gruber summarizes Apple’s starkly limited product line well:

“Apple offers far fewer configurations. Thus, [Apple products] are, to most minds, subjectively better-designed – but objectively, they’re more designed. Apple makes more of the choices than do PC makers.” 

As an analogy, giving someone birthday money instead of taking the time to choose a gift seems eminently logical - why limit the recipient’s choices? But the gifts we remember most fondly are seldom checks.

B) Trying to offer an omni-functional product

Good designers create things with specific uses in mind, which implies making purposeful trade-offs. Another way to abdicate design is refusing to accept those trade-offs; it feels better to make something that could be anything for anyone. Seth Godin calls this a design copout - creating something that “helps the user do whatever the user wants to do,” instead of expressing the creator’s intent.

Once more, Samsung is a prime example; David Pogue summed up his review of the Galaxy S5 thus:

“… if you had to characterize the direction Samsung has chosen for its new flagship phone – well, you couldn’t. There isn’t one … Overall, the sense you get of the S5 is that it was a dish prepared by a thousand cooks. It’s so crammed with features and options and palettes that it nearly sinks under its own weight.” 

This unwillingness to choose, to say no - to exert intent – is also exactly what plagued Microsoft’s Surface, its “no compromises” hybrid tablet/laptop. Unsurprisingly, this jack-of-all-trades device is still a master of none.

Does this mean good design is assertive, ultimately subjective, even restrictive? Absolutely. As Marco Arment put it,

“Apple’s products are opinionated. They say, ‘We know what’s best for you. Here it is. Oh, that thing you want to do? We won’t let you do that because it would suck.’” 

C) Deciding based on user testing

The final flavor of Delegating is a favorite of Internet software and services companies: using A/B testing (or some variant) to see which designs elicit the best metrics from users. Witness the descriptions of how design decisions get made at leading firms:

• Google: “We think of design as a science. It doesn’t matter who is the favorite or how much you like this aesthetic versus that aesthetic. It all comes down to data. Run a 1% test [on 1% of the audience] and whichever design does best against the user-happiness metrics over a two-week period is the one we launch.”

• Amazon: “We’ve always operated in a way where we let the data drive what to put in front of customers … We don’t have tastemakers deciding what our customers should read, listen to, and watch.”

• Facebook: “It doesn’t matter what any individual person thinks about something new. Everything must be tested. It’s feature echolocation: we throw out an idea, and when the data comes back we look at the numbers. Whatever goes up, that’s what we do. We are slaves to the numbers. We don’t operate around innovation. We only optimize. We do what goes up.”

This kind of user testing - often dressed up as “failing fast” or “experimenting” - can be useful, but it’s not design. You can safely bet that Apple has never tested 41 shades of blue on users to decide the right color for its website links.

Look again at the list of companies cited above - Microsoft, BlackBerry, Google, HTC, Samsung, Lenovo, HP, Dell, Facebook, and Amazon. All ten were or are leading, innovative tech companies; all ten could be considered rivals to Apple in some sense; all ten evade the one capability Apple embraces most.

Designing Apple’s Future

What’s noteworthy is that while its competitors avoid design, Apple has been doubling down on it. The clearest example of this last year was iOS 7, Apple’s complete redesign of its most central product. iOS 7′s changes were deeply polarizing, but far from capricious; they were clearly underlain with deep intent.

Gruber correctly characterized iOSes 1-6 as prioritizing obviousness, with buttons and app icons so skeuomorphic, shadowed, and shiny that they looked lickable. iOS 7 did away with much of this ornamentation and use of affordances, and for a clear reason. As Ive explained:

“When we sat down last November (to work on iOS 7), we understood that people had already become comfortable with touching glass, they didn’t need physical buttons, they understood the benefits … So there was an incredible liberty in not having to reference the physical world so literally.”

In other words, as Apple’s intent changed, the design had to also. The new priorities seem to be clarity and order (compensating for the iPhone’s growing capabilities), hardware integration, and what I call “functional delight” - the feeling of joyfully intuitive, effortless actions with immediate, satisfying feedback. You can criticize any of the design decisions they made (and many have), but to do so without considering Apple’s intent is foolish.

This brings us to the present. Many analysts and pundits are puzzling over why Apple is reported to be buying Beats; I suspect Dave Troy and Ben Thompson are on to something:

Troy: The strategy that Apple is undertaking is to reposition the company away from being valued as simply a very good tech company that also happens to have aspirational brand appeal and instead as the world’s most valuable fashion and lifestyle company that provides fashionable, attractive technology through its ecosystem of compatible products.

Thompson: [A]re we witnessing a reinvention, into the sort of company that seeks to transcend computing, demoting technology to an essential ingredient of an aspirational brand that identifies its users as the truly with it? Is Apple becoming a fashion house? 

No outsider knows with certainty why Apple is buying Beats. But consider the following: if design is Apple’s core competency, then that skill should extend beyond computing. And if design can set it apart from all its rivals, then the goal must be to convince the world’s consumers to trust that Apple makes the right design choices for them. “Apple” must mean “great design.” And fashion brands are what we call the signifiers of great design taste.

*          *          *

We tend to think of Ford’s introduction of the assembly line as ushering in an industrywide transition. In reality, the majority of its contemporary competitors struggled to adopt the new system, and were terribly disadvantaged as a result: between 1920 and 1940, over 90% of several hundred U.S. automakers went bankrupt or otherwise vanished.

I don’t expect such a dramatic outcome for Apple’s rivals. But design has lifted Apple to great heights, and I suspect it can take them further. The rest of the world has certainly noticed. But they would do well to think a little harder about what adopting design really means.

The ad is for the struggling Surface 2 tablet. Unable to build momentum since the launch of the original Surface in late 2012, Microsoft has doubled down on marketing its combined laptop/tablet product, and these ads have run for months.

Visually the images are eye-catching, reflecting the company’s new colorful aesthetic. And it does a nice job conveying the core marketing messages: this product combines a laptop and tablet; it’s for both work and play; it’s new yet familiar, etc.

But it was the middle image in particular that stuck out to me. It’s obviously intended to highlight the Type Cover keyboard, and the closeup frames the key with the new Windows logo. But it’s slightly off-center, so that the eye also focuses on the Alt key.

And that’s what stopped me. Why Alt?

Alt has been standard on PC keyboards since at least 1981, and has been lodged next to the Windows key since 1994. Its original purpose was as a modifier, multiplying the possible keystrokes one could input, before the advent of the graphical user interface obsoleted that need. Today, most Windows PC users only use it for a few idiosyncratic functions, like Alt-Tab to switch between windows and the infamous Control-Alt-Delete for logging in and calling up the task manager.

In other words, the Alt key is the quintessential vestige, like the human tailbone – an anachronism. No one designing a new keyboard or operating system de novo today would include it. True to form, Apple – famed for ruthlessly eliminating features that begin to outlive their usefulness – didn’t include Alt on the iOS keyboard for iPhone and iPad. So why has Microsoft kept it?

This gets to the heart of why Microsoft is being disrupted. Every business and product line accumulates barnacles, but for a long time, Microsoft had far more to lose from defeaturing the products at the center of its near-perfect business model than it stood to gain from tearing things down and starting over. When that’s been true for long enough, an organization becomes incapable of severing its vestigial organs and designing from scratch. And when that stops being true, the persisting inability can be fatal.

So even if the ad’s focus on the Alt key is unintentional, the message it symbolizes is quite deliberate. The entire Surface and Windows 8 strategy was a half-step into the future of tablets and touch, and its ads reassure its past customers “Don’t worry. This is familiar. We haven’t made a clean break with the past.“

But the product is compromised and the strategy has failed. Microsoft’s strength has become its weakness. As mobile rises and the personal computer falls, all Microsoft can do is stand athwart progress yelling Stop.

In a world where Apple ritually kills its darlings, where Google launches moonshots no one sees coming, and where Samsung employees still live by their chairman’s order to “change everything but your wife and kids,” Microsoft advertises a brightly colored, defunct key more than 30 years old. Like Gatsby, Microsoft tragically fights for a future that continues to recede into the past. All it’s advertising is its own failure to adapt.

For a long time, the answer has been “more.” Ever since Frederick W. Taylor did time studies of steelworkers with a stopwatch in 1900, the measurement of business activity – called “Greater Taylorism” by Walter Keichel in his business history “The Lords of Strategy” - has grown ever more central to management. One result of this drive to quantify and analyze has been that senior executives often create numerous profit centers, or isolated groupings of both revenues and expenses nested within large businesses.

The two benefits are obvious. First, profit centers allow these executives to make better decisions. In organizations whose various revenue and cost accounts are not linked, poor economic performance can be hidden by positive results elsewhere, and decision-making is clouded. Second, profit centers help make accountability clear. By giving managers direct profit and loss responsibility, companies can incentivize activity that measurably contributes to the bottom line.

So in most large companies, different business divisions and geographic regions are organized as distinct profit centers. Increasingly, product lines, key customer accounts, or brands are treated as mini-businesses as well, like at Procter & Gamble, where global brand managers have P&L responsibility. For that matter, why not functions too? Some organizations are establishing transfer prices for supplies and services between business departments (such as manufacturing and sales), and then measuring, and rewarding based on, the income of each.

There’s just one problem. We optimize what we measure. And the entire logic of profit centers rests on the assumption that maximizing the pieces will maximize the whole.

Unfortunately, this shortcut often isn’t true. Exceptional, sustainable results derive from great strategy, and great strategy isn’t additive – it relies on the way individual pieces fit together in a system, so that the whole is greater than the sum of the parts.

Decision scientists know this – in their models, it’s the difference between finding the local optima (the best result within each “neighborhood”) and the “global optimum” of the whole system. For that matter, football coaches know it too; no professional coach would argue that the best way to win a championship is to focus on maximizing each individual player’s performance statistics.

Yet this is exactly how many businesses are run. Rather than sacrificing certain parts for the good of the whole, companies essentially force each division to stand on its own. This approach undermines strategic fit, which, as Michael Porter put it, “requires the integration of decisions and actions across many independent subunits.”

For a coherent strategy to work, then, the organization executing it must be measured as a whole, rather than as parts. In other words, if a company is to have a single strategy, it must be driven by a single P&L.

This may sound like an extreme position. Yet some of the world’s most successful companies operate this way. Apple famously has only one P&L, for which its CFO, Peter Oppenheimer, has direct responsibility. And while each of its major hardware product lines is priced to make a significant profit, it bundles in all its key software upgrades, products, services, and platforms for free. CEO Tim Cook explains the logic:

“We manage the company at the top and just have one P&L, and don’t worry about the iCloud team making money and the Siri team making money. We want to have a great customer experience, and we think measuring all these things at that level would never achieve such a thing.”

It’s Apple’s single-company mindset that lets it give away industry-leading software and cannibalize its own products, which in turn has led to its unprecedented success. But that’s not to say a single P&L is always the right answer. Instead, a company should have as many P&Ls as it does distinct strategies. P&G’s Gillette shaving brand has a very different strategy from its Bounty paper towel brand, and Gillette has a different strategy in India than in North America. But although Gillette sells its razors and blade cartridges separately, these products fall under a single strategy. P&G’s profit centers reflect these boundaries.

Of course, companies should still measure a division, product, or function’s profitability (to the extent it can be done accurately) – that’s just good management. But this shouldn’t be the primary basis upon which managers are held accountable for their decisions, or they won’t enact a strategy that looks beyond their narrow interests. Amazon wouldn’t be able to underprice and over-market the Kindle to achieve their larger strategic objective of selling content if the Kindle product manager’s main objective was to maximize hardware profits. Nor would “free” look like such a great price point for Google’s Android unit.

So measure carefully – because if you reward each area of your business for acting in its own best interest, you just might get what you wish for.

Or can they? Allworth draws a connection between Samsung’s status as a major Apple supplier and their emergence as Apple’s most (perhaps only) formidable competitor in smartphones. The patent lawsuits over whether Samsung’s products copied Apple’s designs, he says, are a distraction. The real threat to Apple is that Samsung, as one of its key suppliers over the last five years, may have learned to build the critical capabilities it takes to develop and rapidly ramp manufacturing of huge volumes of incredibly powerful and beautiful smartphones at low cost – no doubt one of the most difficult feats in business. As Allworth says, “Perhaps [Samsung] didn’t have to copy Apple. What happens if Apple had already taught them?”

The ramifications of this can be seen in the history of other tech giants. Allworth quotes his book, cowritten with Clay Christensen, in describing the dangers of increasing outsourcing to a key supplier over time:

Asus came to Dell and said, “We’ve done a good job fabricating these motherboards for you. Why don’t you let us assemble the whole computer for you, too? Assembling those products is not what’s made you successful. We can take all the remaining manufacturing assets off your balance sheet, and we can do it all for 20 percent less.”

The Dell analysts realized that this, too, was a win- win…

That process continued as Dell outsourced the management of its supply chain, and then the design of its computers themselves. Dell essentially outsourced everything inside its personal-computer business—everything except its brand— to Asus. Dell’s Return on Net Assets became very high, as it had very few assets left in the consumer part of its business.

Then, in 2005, Asus announced the creation of its own brand of computers. In this Greek-tragedy tale, Asus had taken everything it had learned from Dell and applied it for itself. It started at the simplest of activities in the value chain, then, decision by decision, every time that Dell outsourced the next lowest-value-adding of the remaining activities in its business, Asus added a higher value-adding activity to its business.

In other words, in Dell’s own quest to cede lower-value work to a supplier, it helped that supplier forward-integrate into higher-value work and become a competitor. Fast-forward to the present, and according to Gartner, Dell’s share of PC shipments fell from 16.4% leadership in 2005 to 10.5% last quarter, while Asus has risen from nothing to to 7.3%. Dell built the staircase for its supplier to climb until it was no longer just a supplier. Allworth wonders whether Apple is falling into the same trap with Samsung.

Now, Apple is not yet outsourcing to Samsung (or any one supplier) nearly as much of its value chain as Dell had to Asus by the time Asus was able to launch its own brand. Other differences between the cases abound, so some have criticized Allworth’s post for positing based on a weak analogy with an N of 1 (see his post’s comments).

But what if there’s a pattern? What if Samsung had, in fact, done this before?

In a separate, far-ranging article, the investigative journalists at the Japan Subculture Research Center sought to untie the numerous possible causes of the long, horrifying decline of Sony, once the world’s preeminent consumer electronics company but which expects to lose $6.4 billion this year. Their analysis homes in on the tenure of CEO Nobuyuki Idei from 1999 to 2005, who restructured the company and eliminated many key engineers. According to Sony insiders, these were gobbled up by Samsung, the rising South Korean conglomerate which had become a major component supplier to Sony for technology such as LCD panels.

These panels were used in large flatscreen TVs – last decade’s equivalent of smartphones, in terms of how their huge popularity drove fierce technological innovation and manufacturing capability development. As one Sony veteran put it, “It was better than industrial espionage—Samsung could openly ‘buy’ the technology that Sony had developed simply by rehiring their best and brightest.” An investor remembers a key meeting with Idei:

When the investor pointed out that Sony’s operating profits on electronic products were roughly 2-4% and that Samsung was making similar products at a 30% profit margin, Idei hushed him by saying, “They make the parts for our products. We put them together. It’s the difference between a steel maker and an automobile maker. We make the automobiles.”

The investor countered, “Well, I’ve got news for you—the people you laid off from the car plant are now working at the steel mill, and soon the steel mills will be building cars with your technology.”

In the early 2000s, of course, Samsung forward-integrated and began building high-quality LCD HDTVs at lower cost than dominant Sony. By the middle of the decade it had surpassed its erstwhile customer and partner. This year, Samsung’s share of the category is 29%, while Sony has fallen to 8%. As pundits have noted, “The speed with which Samsung has overtaken its competitors is fairly remarkable.”

Apple has since replaced Sony as the world’s largest and most respected consumer electronics company. This situation is not perfectly comparable – for example, there is no evidence that Samsung is hiring key Apple engineers. But Samsung has become one of Apple’s most important suppliers, and is now also by far its most significant competitor. We’ve seen this movie before. This is Samsung’s style.

As Allworth puts it, this is no longer about whether Samsung aims to use its supplier experience with Apple to replicate its capabilities advantage. The key question is “is it already too late?”

The thesis goes like this: the scaled-down iPad is not a new product but a line extension, with no raison d’être other than to plug a gap between iPhone and iPad as a competitive defense against lower-priced devices like Amazon’s Kindle Fire and Google’s Nexus 7. My friends shake their heads in puzzlement: Apple’s not supposed to imitate rivals and fill in spaces on a chart. They’re supposed to develop revolutionary, blue-ocean products. They’re supposed to redefine how people think of computers. Apple must have lost its mojo.

These people are wrong. Apple is following the same playbook it has for the last fifteen years – redesigning the computer to perfectly fit underserved jobs-to-be-done.

Steve Jobs deeply understood that the personal computer is the most powerful and flexible tool ever built, yet it was trapped for decades in a shape Apple itself created – a box with a monitor, a keyboard, and a mouse. Put computing power in any other form factor and no one recognizes it. We saw the iPhone as just a flashy smartphone, rather than a disruptive minicomputer. The iPad was just a big iPod Touch. And the iPad mini is just a shrunken iPad, right?

The problem is that at first, we see these devices in terms of their appearance and features. What we don’t see is how we’ll use them. When the iPad was first introduced, more attention was paid to “missing” features like USB ports than to the facts that it could be awakened instantly and had 10 hours of battery life. But these attributes radically change how a computer will be used. Few people casually grab a laptop off their bedside table to watch a movie while lying on their side.

Apple gets this. As Phil Schiller unveiled the iPad mini on stage, all he talked about were what the tech community calls “use cases”:

“So what else can we do to help customers find even more uses for iPad, to use it in places they never imagined, in manners they never have before? … What can you do with an iPad Mini that you can’t already do with the amazing 4th generation iPad?”  

As he began to answer that question, the first thing Schiller did was demonstrate that it was easier to hold with one hand. That may not seem like a radical departure from something already as portable as the iPad, until you look at the use cases it enables. In the Apple keynote, I noticed two in particular for which Schiller reserved his most superlative adjectives. The brilliant Apple observers John Gruber of Daring Fireball and MG Siegler of parislemon and TechCrunch immediately honed in on the same two in their respective iPad mini reviews:

1) Gaming:

• Schiller: “If you love playing games, playing incredibly amazing games, like Real Racing 2, are incredible on the new iPad.”
• Gruber: “I was not expecting iPad 3 performance in the Mini. But it’s there, and that makes the iPad Mini great for games. I think there are going to be a staggering number of iPad Minis in Santa’s sack this year.”
• Siegler: “[Gaming is] clearly where this new iPad is going to shine … If Apple had only made the iPad mini as a gaming device, I think it would be one of the best-selling gadgets of all time … Playing games on the iPad mini is fantastic because the device is much easier to hold for extended periods of time in the landscape position.”

2) Reading

• Schiller: “It’s fantastic for kicking back and reading a magazine or a book on.”
• Gruber: “The Mini feels optimized for reading”
• Siegler: “Books, magazines, and reading apps are likely to be another big use-case for the iPad mini.”

This isn’t rocket science. People also use the regular iPad (as well as the iPhone and traditional PCs) for gaming and reading – both massive markets. But neither is really well suited for those tasks. You don’t need a 9-inch screen or a life-size QWERTY keyboard for either, and arms tend to tire holding something that weighs a pound and a half for hours. Yet the iPhone is too small. The iPad mini is perfect.

If you think about products in terms of use cases rather than features, Apple customers now have legitimate reasons to own as many as five Apple devices. It’s not hard to imagine strapping an iPod nano to your arm for your morning run, using an iPhone as your all-in-one pocket communicator throughout the workday, reading or playing games on an iPad mini to pass your travel time, doing heavy emailing and other work on a MacBook, and leisurely watching evening shows and movies on an Apple TV. All of these devices could be classified as computers of some sort, and their feature overlap is high. But Apple has built each to do different jobs. Depending on what you like to do, you may only own one or two of these, but you don’t have to settle for a device that tries to be everything to everyone.

Pundits and analysts think about what products can do, but Apple thinks about what people will do. That’s why the iPad mini is misunderstood.

In short, Apple has once again introduced a new product using familiar technology, but built for different use cases from previous products. As usual, the initial response has been disappointment. And as usual, it will sell in the tens of millions. It seems to me that Apple hasn’t changed one bit.

On the surface this looks like a terrible idea. Since the launch of Apple’s iPad last year, tech titans including Samsung, HP, Motorola, and Research in Motion have all fast-followed with their own tablets, but the outcomes have been uniformly disappointing – John Gruber at Daring Fireball estimated that, even including Nook Color e-readers, the iPad’s share of the category is in the ~95% range. As Marco Arment put it, “[t]here really isn’t much of a tablet market. There’s an iPad market.” It’s widely agreed that Apple has the best tablet OS, form factor, and specs, plus the most apps and the strongest brand. It’s believed that Apple also has a cost advantage (due to early investments in suppliers’ production facilities), enabling entry level iPad pricing that none of the other major players have been able to beat.

So trying to enter this market as the 14th or so player doesn’t sound like a smart move for Amazon. Unlike the aforementioned hardware makers, it could easily sit this game out. Or could it?

Crazy Like a Fox

Amazon is a retailer that, despite its ever-growing “A to Z” product offering, still makes 40% of its revenue - and even more of its profit – by selling software and content, like books, movies, music, and games. This media, not physical goods, is still Amazon’s selling focus. Don’t believe me? Check out the department list at the left side of its home page – right now it reads:

• Unlimited Instant Videos
• MP3s & Cloud Player
• Amazon Cloud Drive
• Kindle
• Appstore for Android
• Digital Games & Software
• Audible Audiobooks
• Books
• Movies, Music & Games
• Electronics & Computers <- Finally, ten items down, the actual physical stuff!
• Home, Garden & Tools
• Grocery, Health & Beauty
• Toys, Kids & Baby
• Clothing, Shoes & Jewelry
• Sports & Outdoors
• Automotive & Industrial

It’s often been said that Apple makes money selling devices, and uses its software and content (e.g., iTunes) to drive those sales. Amazon does the reverse. Being the content-retailer of choice is so important to them that they designed and marketed an intuitive e-reader, the Kindle, just to ensure they’d own the e-book space. (A side note: crucial to Amazon’s success here was the realization that, in the digital media retailing world, “purchasing” and “consuming” activities would converge in a single device.) Even with a beautiful piece of hardware, Amazon was clearly tempted to view it as a mere complement for their true aim (selling digital media) in a razor-and-blade strategy. Which is exactly what Amazon’s been doing: rapidly dropping Kindle prices to get devices in the hands of as many users as possible (the ad-supported version is now only $114 and, in a sense, the Kindle app in every mobile store is essentially a free version of the device). This strategy shares elements with the idea of commoditizing your complements – in both cases, a cheaper complement (e-reader) helps you sell your money-maker (e-books).

In the meantime, of course, Apple has launched its own iBooks app and store on its iOS devices, a credible second-runner to Kindle. In theory, Apple doesn’t need to have its own content stores on its devices – if customers decide they like using the Kindle app for e-books (or, say, the Netflix app for movies), that would still help Apple sell iPads and iPhones. But Apple knows that providing its own proprietary, well designed content stores and formats will increase user stickiness and earn them a nice pile of cash on the side. So Amazon built a device to help them sell e-books and Apple built an e-bookstore to help them sell devices.

In an alternate universe, a fragile peace could have emerged between Apple and Amazon, with each holding a knife against the other (a strategic phenomenon known as spheres of influence). But unfortunately for Amazon, the Kindle was only a minor threat to Apple’s ability to use e-reading to sell devices, while Apple’s “knife” was and is much bigger. Apple recently announced it has sold 222 million iOS devices, all of which have iTunes (movies and songs), the App Store (software and games), and now the iBookstore. In other words, the sheer speed of Apple’s success in selling devices has made its threat a reality: it’s already become a dominant software and content retailer.

This position has emboldened Apple to muscle Amazon around a bit. This week, Apple began enforcing an earlier threat to take a 30% cut of every publisher sale made through an iOS app (like Kindle), as well as disallowing in-app buttons that took readers out of the App Store to make a duty-free purchase. Unable to cope with such a burden, Amazon – as well as Barnes & Noble, Borders, Google, and purveyors of other types of content like Rhapsody – removed the stores from their apps on Monday.

While users can still use Apple’s mobile browser Safari to access the Kindle store and download content, this is obviously a huge blow to Amazon’s ability to retail content. Controversy aside, Apple clearly knew that most digital retailers would choose to close up shop rather than pay such huge fees. A lot of pundits have missed this point – Apple isn’t trying to make money by taxing iOS users’ purchases in other companies’ stores. It’s trying to be the only good store in town (a la iTunes), and it’s doing it by crippling Amazon’s ability to have a store on the turf Apple owns. Amazon and the other companies aren’t revolting, they’re getting run out of town.

This is why Amazon can’t sit the tablet game out. To sum up, they’re basically looking at four facts that, combined, spell big trouble for them:

1. Selling digital content and software is extremely important to Amazon.
2. People want to buy (and consume) digital media on highly functional mobile devices (i.e., smartphones and tablets).
3. Apple reigns supreme in those product categories.
4. Apple’s aggressively preventing Amazon from selling digital media on Apple devices.

The only link in that chain that Amazon feels it can attack with any chance of success is #3.

And in This Corner…

The good news for Amazon is that, because it’s aiming to put devices in people’s hands primarily to enable selling them content and software, it doesn’t have to adopt the same “me-too” strategy that’s so dismally failed the other hardware manufacturers. One big key to success is a low price: a Retrovo study indicated that this was a huge selling point to potential tablet customers, and that a price in the $250-400 range could garner significant share relative to iPads at $500-830.

Is a price that low even possible? That depends on two things – first, Amazon would have to keep costs to a bare minimum. There’s plenty of signs that’s exactly what it’s doing – from outsourcing manufacturing to a large, experienced Asian producer (possibly Samsung), to using a simpler, smaller touchscreen, to forgoing cameras. It could also save money by using lower-cost processors and chips and having less flash memory storage. But another part of keeping the price down is relinquishing device profitability. Unlike the huge margins sought by Apple, Amazon can adopt the razor-and-blade strategy (possibly even accepting a loss on each tablet sale) and try to make it up on subsequent revenue from the digital media users buy on the device. Through a combination of these two tactics, I bet Amazon could price a tablet below $300.

The second big key to success, however, is the right user experience and capabilities. Some, such as MG Siegler, doubt whether customers would even want a stripped-down tablet from Amazon. But I believe it has an opportunity here to capitalize on its strengths and create the ideal content discovery and consumption device, rather than the ultra-flexible machine Apple’s designed. Imagine a tablet perfectly designed to find, buy, and consume books, newspapers and magazines (via the Kindle app), audiobooks (via Audible), music (via a rebranded Amazon MP3 and Cloud Player), movies and shows (via Amazon Instant), games, and other software (via the Appstore for Android). Running the Android Honeycomb OS, the tablet could tightly integrate these features in a simple interface with Amazon’s Cloud Drive for storage and syncing, Amazon’s excellent loyalty program Prime (with perhaps a free year’s membership), and an improved recommendation engine for discovery. General tablet functionality like web browsing, email, and social media would be key secondary features, while more advanced apps and capabilities – perhaps including 3G service – might be absent altogether. In many ways it might resemble a better-packaged Nook Color.

Could Amazon pull this off? Despite not yet having a tablet, Amazon’s brand is strong enough that a majority of potential tablet customers would consider buying it based on name alone. If Amazon nailed the pricing and user experience described above and added some brilliant marketing, I think it could be the first non-iPad tablet to sell in the multi-millions. That’s not the whole battle, though – Amazon would still have to convert enough digital media purchases to make it all worthwhile. Here’s where Amazon’s strengths in retail, pricing, and loyalty could really pay off. Amazon also just signed up 100 newspapers and magazines to deliver full-color issues to subscribers in the Kindle app, a sign that content creators still have faith in Amazon’s experience in selling and delivering digital media.

Ready for War

Any way you slice it, Amazon is making a huge bet by entering the tablet market. I don’t think anyone realizes how high the stakes are for them, and thus for Apple too. On the one hand, Amazon’s success with the Kindle, combined with CEO Jeff Bezos’ strategic direction (and the inevitable feeling of having one’s back against the wall) bodes well for an Amazon tablet. On the other hand, selling an Amazon tablet means convincing consumers not to buy the most successful consumer product ever. The last thing I would tell a company that spends half its energy battling Walmart would be that it should start spending the other half going toe-to-toe with Apple.

But Amazon is gritting its teeth and marching onto the field. The clouds have gathered. Get ready for a rumble.

What’s happened since then? Shares of Apple (AAPL) closed today at $386.90, up ~23% from the June 20th close of $315.32. In other words, in one month Apple created over $60 billion of shareholder value (measured by change in market cap). Not too shabby.

Their earnings report yesterday (which blew away the analyst consensus by 33%) had a lot of interesting data on their rocketing sales by product and region, but the most important thing about their share price growth over the past month is that there hasn’t been any single major driver, like a huge product announcement (its recent patent wins were about as close as it came). Instead, Apple’s just been consistently executing on a great strategy.

Of course, a month is nothing in this game – we’ll check back again in 6, 12, and 24. But remember that performance is a lagging indicator of a successful strategy, which is why smart amateurs that understand Apple tend to out-predict the Wall Street pros. A good example is John Gruber of Daring Fireball, who picked up on a strategic shift when Apple announced the iPad a year and a half ago:

There was a meta-message in today’s Apple event, not about the iPad in particular, but rather about Apple as a whole … [T]his is Apple’s way of asserting that they’re taking over the penthouse suite as the strongest and best company in the whole ones-and-zeroes racket.

Some people have asked me why I write so much about Apple. This is a company that was almost dead 15 years ago, but is now in the running to becoming the most valuable company in the world. Strategy and innovation is how they did it.

Apple recently released a completely redesigned version of its advanced video-editing software, Final Cut Pro X. Amateur movie-makers such as the New York Times’ David Pogue praised its ease of use, but the reaction among professional video editors was scathing. Missing features and other changes were slammed. With regard to the negative feedback he got following his review, Pogue said he’d “never encountered anything quite like this.” The pro crowd was so incensed with what was termed Apple’s “failure,” “worst launch,” and “biggest mistake in years” that speculation quickly turned to what Apple could have been thinking. Some suspected that it intentionally stripped away critical features to “dumb down” its product and appeal to the much larger amateur editing market – a theory that only angered the pros further. Pogue himself emphatically argued that Apple didn’t intentionally turn its back on the professional market – instead, Apple just “blew it.”

Pogue is wrong. As Sachin Agarwal (founder of Posterous and a former Final Cut Pro product designer at Apple) put it, they knew the Final Cut Pro X redesign would be controversial. He described the rationale for their decision bluntly: “Apple doesn’t care about the pro space.” Nor does it compete on features – it “doesn’t play that game.” Instead, Apple took a professional-grade product down-market by making it simpler, cheaper, and more intuitive – and to do this, they changed and eliminated functionality.

What’s funny is that this has always been Apple’s strategy. While IBM made faster and more powerful PCs for the technical elite in the 1980s, the Macintosh had less RAM but introduced a mouse and graphical interface that any user could understand. More recently, many critics thought the iPad would be dead on arrival because of the features it lacked, but a few, such as John Gruber, understood that Apple was making a conscious trade-off - ignoring the feature-seekers and tinkerers in order to create the world’s most intuitive computer, cheap and capable enough for the mass market.

Did Apple have to choose? If it tried to design software or devices for both laymen and the elite technical segment, it would be forced to make a thousand subtle sacrifices to pull off the straddle – on features, UI, price, marketing, etc. In the end, it might still have made great products, but not as good as those it has now.

The risks of failing to choose are all too apparent when you consider some of the biggest disasters in the high-tech industry recently. There are eerie parallels between last week’s anonymous Research in Motion open letter to the CEOs (“instead of chasing feature parity … [t]here is a serious need to consolidate our focus…. Strategy is often in the things you decide not to do”) and Yahoo’s infamous 2006 leaked “peanut butter” memo (“We want to do everything and be everything – to everyone…. The result: a thin layer of investment spread across everything we do and thus we focus on nothing in particular…. We need to boldly and definitively declare what we are and what we are not”).

Contrast these with Steve Jobs’ philosophy on strategy, repeated endlessly over the years: “People think focus means saying yes to the thing you’ve got to focus on. But that’s not what it means at all. It means saying no to the hundred other good ideas that there are. You have to pick carefully … We’re always thinking about new markets we could enter, but it’s only by saying no that you can concentrate on the things that are really important.”

RIM’s share value is down ~33% over the last month. Yahoo’s is down ~60% over the last five years. By contrast, since Jobs returned to Apple, its share value is up almost 10,000%.

Michael Porter might say that the Final Cut Pro X debacle is exactly why Apple is the most successful company in the world.

The pundits’ argument is based on sensible Econ and Strategy 101: Apple is making a killing now, but that’s because it was first out of the gate with these products, and without some kind of protective moat, all good things must pass, right? Apple doesn’t seem to have an insurmountable barrier or killer app (like iTunes with the iPod). Therefore, the fast followers will catch up on Apple’s hardware capabilities and apps, and price-compete their way to share. The only question is how long it will take.

One big counterargument, of course, is that Apple has core competencies that not only got it out of the gates first, but enable it to run faster too – particularly in innovation and design. By the time Samsung caught up to the iPad, the iPad 2 was already around the next corner.

In the tablet market, Gruber, John Paczkowski and others make a second argument too – that catching up to Apple isn’t good enough. To really win, a competitor like Samsung, RIM, or Dell has to provide a good answer to the question “why should somebody buy this instead of an iPad?” But this only hints at the much bigger moat Apple’s built around itself: its brand.

Many techies see a brand as an elaborate marketing ploy companies use to appeal to the emotional part of consumers’ minds, and a lagging indicator of success. In other words, you can fool consumers for a while, but your brand will stay strong only if the products are; either way, a brand doesn’t itself create lasting success.

This misapprehends what a brand really is: a promise in the mind of consumers. Unlike, say, five years ago, today most of the extremely high value of Apple’s brand doesn’t come from its ads, its fanboys, or even its retail stores. It comes from average consumers’ experiences.

Imagine a non-techie thinking about buying a new smartphone or a portable computer. Even if she’s never been in an Apple store, there’s a decent chance she got an iPod Nano as a present at one point. More importantly, she almost certainly knows many people who have bought an iMac, iPod, iPhone, MacBook, or iPad over the past decade, in various versions and combinations.

What impression of Apple has this given her? Almost certainly, it’s been overwhelmingly positive, because Apple hasn’t launched a crummy new product in a long time – and that includes both new-category (iPad 1) and next-gen (iPhone 3GS) devices. And here’s the key – when it comes to sales, it’s OK to have a bunch of misses, so long as you have a few big hits. But with a brand, misses hurt. People hate wasting money, and they know they’re taking a risk when they buy a major new piece of technology, same as when they go to a pricey new restaurant. If people talk about how a product kind of sucks, that won’t just hurt sales of that product – it hurts sales of the next one too. The opposite is also true.

Four or five years ago, even if you heard great things about Apple products, it was still acceptable to brush them off – sure, the iPod was cool, but I’m not sure about this new phone. But now, in consumers’ minds, Apple has been batting pretty close to a thousand for a decade. And that’s its best asset – the fact that you can’t sneeze without hitting five people who’ll tell you they love their iPad, will never switch from their iPhone, or that their Macbook “just works” – and zero who say otherwise. In other words, it’s the brand. We’ve been surrounded by great Apple experiences for so long now, we’ve been trained what to expect – if Apple announced it was coming out with a washer/dryer, we’d laugh, but we’d also immediately form some positive expectations about how it would look and function.

That’s why it’s getting harder to defend buying anything but an Apple product: simply because you can be confident you’ll like it. Tech mavens might always be willing to adopt the “best” product, but most consumers are more wary. If Samsung, RIM, Dell, or anyone else today announced a tablet that had 13 good reasons why everyone should buy it instead of an iPad, tomorrow most people would still buy iPads, because the one reason that really matters to the average Joe is risk. Technology is complicated and often disappointing, but Apple’s brand credibly promises people that they’ll love the next thing they buy that has a little bitten apple on it. Other tech brands can’t do that without sounding like the Boy Who Cried Wolf. And one great product won’t close the credibility gap – they’ll need a decade of great products, with almost no misses. The kind of trust Apple’s built up creates incredible momentum. That’s why the “tablet market” is Apple’s to lose.

In other words, Apple’s profit growth is explosive, but as I write this, its P/E is still in the mid-teens (currently 15.0). Google’s is 18.8. The S&P 500 overall is 22.6. Amazon’s is 81.3.

This means either the market is expecting Apple’s growth to slow dramatically, or it believes Apple’s future earnings to be highly risky – or both. Whatever the case, Apple’s stock is down 10% in the past four months.

This is absurd. Would anyone in his right mind actually bet against Apple’s earnings growth right now, given the sales it’s posting for iPads, iPhones, and iMacs? If this is a Steve Jobs story, it’s hugely overblown.

Prediction: Apple will continue to outperform the S&P and tech peers like Amazon over the next 6, 12, and 24 months. I’m putting reminders to check back into my calendar.

Buy now.