Case Study: Apple, iTunes and iPod

News: several European countries are trying to force Apple to open its online music service iTunes to other MP3 players than the iPod.

Analysis: when a company sells two tiers of a solution (like the MP3 player and the online music service), it can favor one at the expense at the other. If you indeed open tier #1 to work with other third party tiers #1, this is at the expense of tier #2. Tier #1 becomes more popular because it can work with more counterparts, but tier #2 becomes more marginalized.

But Apple has decided to go another way: you can only use iTunes with the iPod, and vice versa. Because both products are leaders in their categories, this is a virtuous cicle as they reinforce each other. iPod users are forced to use iTunes if they want to buy music online. And once they do, they are forced to stay on iPod if they want to be able to listen to the songs they purchased. Note that Apple is probably following this strategy not because it's sound, but because it's in its culture to try to sell us all the components of a solution (the first Macintosh could only work with an Apple printer).

Now, if Apple was forced to abandon this model, it can favor one tier at the expense of the other:

Open iTunes to other MP3 players (at the expense of the iPod): one solution is to allow other MP3 players to use its proprietary AAC music format. But it can also let iTunes sell music in other formats. The latter option would allow to keep the iPod market captive.

Open the iPod to other online services (at the expense of iTunes): this can mean by either having the iPod recognize other song formats, but it can also mean allowing other online services to sell music using Apple's AAC format (Real Networks tried to). The latter option once again would allow to keep iPod users captive (you bought a song while you had an iPod? You can't play it anywhere else). One the one hand, people might be more enclined to buy iPods because they wouldn't feel so captive. But on the other hand, Apple WANTS its iPod users to be captive.

But even with legal constraints aside, Apple's current strategy might be difficult to sustain in the long term. Competition is trying very hard to catch up, and Apple may not be #1 in both the MP3 player market and the online music purchase market.

Microsoft has defined its own copyright-protected music format, and is making sure that pretty much any player and any online music service. They applied the exact same strategy on the PDA market, and see where is Palm now... Sure, Apple has an edge on the competition right now. But keeping that edge forever might be difficult.

Also, the music majors would like very much to increase the price of some songs. Apple CEO Steve Jobs didn't let them because his company's market share gives him a strong negotiating power, but chances are they will try again to get their way and will ditch Jobs as soon as they have the opportunity.

Now, if tomorrow Apple is forced to focus on only one of the two products, which one would it be? My guess would be the iPod, for several reasons:

• Apple is an engineering company at heart, and coming up with devices that can't be easily copied is what they do best.
  
• If it were not being the only online music store for the iPod, iTunes doesn't have a strong competitive advantage (no online store has).
• Even if iTunes is a strong revenue generator, the iPod enjoys very comfortable margins: around 50% for an iPod Nano when sold in an Apple store, more for other models.