When Apple announced its new iCloud service, it wasn’t just acknowledging the power of cloud computing or even the failures of their previous fee-based MobileMe cloud service (though they did exactly that). Instead, the decision to provide free iCloud services to every user of a device running iOS 5 or Mac OS X Lion reflects an extension of Apple’s long held strategy of selling premium-priced hardware while throwing in software for free.
For as long as Apple has been selling computers, people have debated whether the company is at heart a software maker or a hardware purveyor. In reality, the two are not disparate parts of the company, something which sets it apart from many of its competitors in the technology world.
Apple’s priced hardware, free software strategy is similar to the Gillette razor metaphor, but in reverse. Where many companies provide free or subsidized hardware to spur sales of software, services, or another commodity—think HP with printers and ink, Google with Android and advertisements, Microsoft with Xbox and game licensing—Apple is subsidizing the iCloud service to sell more iPhones, iPads, and Macs.
Apple is not the first company to experiment with offering free services to sell more hardware. Many luxury car manufacturers throw in a few years of free maintenance on top of the usual warranty to entice buyers and justify the price premium. But these free services merely make continued operation easier. Apple’s free iCloud service differs by substantially expanding the functionality of every iPhone, iPad, and Mac, rather than providing a mere tune up.
iCloud isn’t Apple’s only freebie. Software updates for the operating system that runs iPhones, iPads, and other small devices, iOS, are also offered free of charge. In practice, this means about two to three years of software updates are included in the up front cost of the hardware before it becomes obsolete. Apple also appears to be moving in the same direction with its Mac lineup by offering Lion for $29 per user, down substantially from previous major Mac OS X versions, which sold at $129 per machine. To be sure, Apple never received $129 per updated Mac. Mac OS X has never required a serial number, nor has it phoned home to ensure only one license existed per computer, so many users purchased one copy and installed it on every computer they owned. In moving to the cheaper, per user approach, Apple seems to be both acknowledging how people used and installed the software and recognizing that their profits come primarily from new hardware purchases, not paid OS updates.
A recent change implemented by the Financial Accounting Standards Board may have enabled Apple to offer free software updates that add substantial functionality without running afoul of regulators. In the past, if a company wanted to add functionality via software updates, it had two options: One, charge for the update, or two, recognize revenue from the initial sale over many quarters. The iPhone went on sale before the rule change, and Apple conservatively decided to spread the revenue over two years to allow for free software updates. This meant they were sitting on a large pile of unrecognized revenue, though, which was not ideal. Under the new rules, Apple can recognize more of the revenue up front. Accounting rules are no long complicating free software upgrades.
Apple’s bundling of free software and services with premium hardware will only offer a competitive advantage if all three work together seamlessly. Given the difficulties Apple had in running its cloud-based MobileMe product, that’s not a foregone conclusion. But on the other hand, Apple may well have learned from its past mistakes in the cloud. If so, iCloud, iOS, and Lion could help Apple stay on top.