[A2k] Economist: Apples are not the only fruit

[Thiru Balasubramaniam]

http://www.economist.com/finance/displaystory.cfm?story_id=3D7141363

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  Apples are not the only fruit

Jul 6th 2006
 From /The Economist/
edition


    The economics of France's attempt to open up iTunes

APPLE COMPUTER prides itself on creating products that fit together
without ugly joins or haphazard stitching. The iPod is a prominent
example. A portable digital jukebox, it works seamlessly with Apple's
own iTunes music store, a popular site for buying downloadable music.
But on June 30th France's Senate and National Assembly did their best to
unpick Apple's careful weaving. The law they passed is supposed to allow
customers to play music bought from iTunes on one of the iPod's rivals.
Consumers, the French hope, will be able to mix and match players and
stores as easily as they do ties and shirts.

When signed, the law may well be ineffective. Copyright-holders may step
in at Apple's behest and prevent their music being played on rival
devices. If it has any effect, the law may backfire. For Apple, France
is a dispensable nation. The company could quit the country altogether
rather than allow its competitors to take advantage of its music store.
As a result, the law may leave France's digital music-lovers with less
choice, not more.

Put these practical difficulties aside, and ask whether France's
policymakers identified a real problem. Are they right to worry about
the inseparability of Apple's store and its player?

Such controversies normally turn on the analogy chosen to illuminate
them: is the iPod like a CD or cassette player, or an inkjet printer?
Since it appeared in 2001, the iPod has become this decade's answer to
the Sony Walkman. Supporters of the French law point out that if you buy
a music cassette at a shop, you can listen to it on any cassette player
that takes your fancy. You do not have to play it on a Walkman. Why then
can customers not listen to songs from Apple's music store on whatever
player they like? Surely Apple is guilty of exploiting the popularity of
its store to stifle rivals to its iPod?

The law's opponents reach for different analogies. They compare the iPod
not to the Walkman, but to printers, games consoles and razors. Buy an
inkjet printer, for example, and you must buy the manufacturer's
cartridges to be sure that it will work properly. (Although French
parliamentarians will not come to your rescue, European regulators
might.) Indeed, manufacturers make much of their money from the
cartridges, not the printer itself, which is often sold cheaply.
Economists explain this business model as a clever way for companies to
=93meter=94 their customers, charging them according to use. If they could
not tie their customers to their cartridges, they would charge more for
the printer itself, and the kind of person who now uses his printer
rarely would not buy one at all.

Apple's business model, however, turns this on its head. Apple makes its
money from sales of the iPod, not sales of music; the printer, not the
cartridge; the razor, not the blade. As Bill Shope, an equity analyst at
JPMorgan, puts it, the music store is a =93loss leader=94 that serves only
to boost sales of the iPod. It is as if record stores existed only to
sell record players.


    Beware geeks bearing gifts

How vital is this loss leader? Mr Shope points out that iPod sales took
off after the store was launched in April 2003. That said, only a small
fraction of the stuff on a typical iPod comes from Apple's store. Most
of it is still copied from CDs and some is acquired through
file-swapping technologies such as BitTorrent. People do not become iPod
customers to take advantage of the iTunes music store. But, argues Mr
Shope, the store may be an important reason why they stay customers.

Because the music store is only compatible with the iPod, a customer who
wants to abandon Apple's player in favour of something else must replace
all the music he downloaded from the store. It is as though a person's
entire record collection worked on only one brand of gramophone. Hence
with each song a customer buys, he binds himself a little more tightly
to the iPod. Apple offers its customers a =93Trojan horse=94, according to
Mr Shope. Customers embrace its iconic device, and then, like the
hapless Trojans, find they have fallen into the hands of the gift-givers.


Are consumers so easily duped? The so-called Chicago School of antitrust
economists, represented most prominently by Robert Bork, once a nominee
to America's Supreme Court, and Richard Posner, another judge, assumes
consumers are rather smarter than the Trojans were. Customers must know
that any music they buy from Apple will work only on the iPod=97it is not
a secret. If they nonetheless choose to buy it, they must think the
benefits the music store offers outweigh the switching costs it imposes.
No doubt Apple's music store would be more attractive still if it were
opened up to any player. But if Apple chooses not to do this, that is
its business.

Some economists think that this view is too sanguine. They argue that
the appeal, or otherwise, of tying yourself to a company depends on what
other customers do. If everyone else gives up the ability to shop
around, then no rival company can enter the market, because most of its
potential customers are already wedded to the incumbent. And if no
alternative can enter the market, then the freedom to shop around is not
worth very much. One need not worry about switching costs if there will
never be anything to switch to. Applied to Apple, this argument goes
something like this: every time someone buys a song on iTunes, he
becomes a little less likely ever to abandon the iPod and makes the
potential market for iPod's rivals a little smaller.

Mr Shope thinks iPod customers, having spent money on their iTunes
collections, will prove quite =93sticky=94. But Apple cannot rest too
easily. The market is young and customers' commitment may not yet be
deep. Just as CDs prompted record-lovers to abandon their vast
collections of vinyl, a rival to the iPod, were it good enough, could
tempt audiophiles to abandon their iTunes collections=97with or without
help from France.