Did Steve Jobs just kill Flash?
Prepared for:MBA 211-1 Game Theory
Prepared by: Arjun Gupta, Tony Mignot, Hiroshi Shono, ApinunTachaplalert
Date: May 14, 2010
Proposal #:
Introduction
”Perhaps Adobe should focus more on creating great HTML5 tools for the future, and less on criticizing Apple for leaving the past behind.”- Steve Jobs.
For many years now, Apple and Adobe have been in a tug of war pulling their preferred platform to be the industry’s de facto standard for the delivery of video content via internet and the development of mobile applications. However, with the rapid expansion of the mobile market, the rivalry is taking a new turn. By leveraging the increasing market share of iPhones and the recently launchediPads, Apple has begun to take aggressive actions toward Adobe.In this paper, we look at the dynamics of how this game between Apple and Adobe has played out so far and also attempt to forecast how the game will play out in the future.
Players
Apple
Apple Inc. designs and manufactures consumer electronics, computer software, and personal computers. The company's best-known products are Macintosh computers, the iPod, the iPhone and the iPad. Apple’s is unique when compared to other manufacturers of similar products in that they have a highly vertically integrated business model. Apple’s products often run on proprietary operating software and are distributed through their own distribution channel. Apple has sold over 35 million iPhones and over 50 million iPod Touches to date and expects to sell 6 to 15 million iPadsthis year. All of these products run on Apple’s proprietary operating software. Given their significant outreach and the consumer loyalty that they receive, Apple products’ platforms and ecosystemsare a huge market for application developers and advertisers
Adobe
Adobe Systems Inc. is a California-based computer software company focused upon the creation of multimedia and creativity software products, with a more-recent foray towards rich Internet application software development. Their main source of revenue is the Creative Suite which allows web and application developers to create contentson Adobe’s Flash platform. The sales of Create Suite are estimated to have accounted for 60% of Adobe’s total revenue in 2009.[1] Adobe’s proprietary Flash platform is increasingly competingfor the delivery of multimedia content over the internetwith an emerging open technology called HTML5, led by a consortium that includes companies such as Apple and Google.HoweverFlash is estimated to claim a dominant market share of 75% as of today.
The Game
Course of events
Rivalry between Adobe and Adobe has intensified when Apple announced in 2007 that its newly released iPhoneswill not support Flash. Apple has been in support of HTML5, an open platform developed by the World Wide Web Consortium (3WC). (Refer to exhibit A for the list of events taken by both sides in this rivalry.)
Apple has several reasons for trying to keep the Flash platform away from its products. First, it will allow Apple to tie down application developers to the HTML platform and to the Apple ecosystem. Since it can be costly for the developers to create applications for both HTML5 and Flash, developers may opt to develop contents only for HTML5 (however with the big assumption that Apple user base is attractive enoughfor the developers to choose them over other platforms.) This will help Apple differentiate their products by offering of unique applications and contents. Secondly, Apple may be able to improve their user experience by leaving Flash. The lack of compatibility between Flash and Apple operating software is told to be one of themajor reasonsfor software crashes on Apple products. Despite repeated signaling from Apple to Adobe to resolve this issue, Adobe had not yet responded successfully.
For Adobe, maintaining a dominant share in the mobile internet space similar to the one it enjoys in the desktop market is a life-or-death matter. As mentioned above, the sales of Creative Suite make up the bulk of their corporate revenue. By maintaining and leveraging their high market share, Adobe wants to remain the only game in town whichcan supply the developers with the development software they need.
Strategies for Apple
Apple has two major options to consider.
Option 1: Fight
First, they may choose to fight by continuing to lock out Flash from Apple products. Although this may create a temporary dissatisfaction on the part of its current customers, Apple will benefit from increased flexibility in terms of what type of content to offer to end users. Apple will no longer have to rely on or be restricted by the development of subsequent generations of the Flash technology.
Option 2:
On the other hand, Apple may also choose to concede and allow Flash to run on their products or at least allow software developersto use compiler software that convert codes originally written on Flash platform to run usingHTML5, hence also on Apple products.
Strategies for Adobe
Though in a disadvantaged position, Adobe also has a couple of options to consider.
Option 1: Fight
They may choose to fight with Apple by suing Apple with anti-trust charges. If Adobe wins in court, they will regain their entry into Apple products, which will help them maintain high market share. Some industry observers suggest that Adobe is preparing to do so, however the general consensus is that Adobe’s probability of successfully persuading the court is low.
Option 2: Wait
Adobe can also passively wait to see how the developer community and the Apple users respond to Apple’s recent decision to ban the use of compiler software and hope that their voices will force Apple to change their mind. With this strategy, they will forgo the legal fees and risk of further retaliation from Apple that accompanies the first option. However, with this strategy, Adobe will likely see continued decline in the Flash market share especially in the mobile computing space and also seeits revenue significantly decline over time.
Analysis of the game
Quantitative analysis of the game
Constructing the Player’s Payoffs – Methodology & Assumptions
To arrive at the payoffs for the individual players in such a dynamic game, we attempted to create a dynamic payoff model thatrepresented the real situation. Nevertheless given the number of players involved, and to accommodate the situation within the tools learnt during the course, the following assumptions were made:
- Apple’s customers were segmented into two
Loyals – stick with Apple irrespective of not having access to tons of Flash based web content, even in the long run.
Shoppers – not so loyal to Apple, and may shift to competitors if denied access to Flash based content in the long run
- The proportion of shoppers sticking with Apple’s even in case of continued no Flash access on Apple products, was deemed to be linearly proportional to fall in Flash’s market share. The reasoning behind this was that if other platforms like HTML5 took off, and Flash’s dominance reduced, then a smaller proportion of shoppers would shift from Apple products. This reflects the affect of one player’s position on the payoff of the other as close to what would be the case in the real scenario
- The payoffs for both players were held contingent to Flash’s market share for online media
- It was assumed that in the remote possibility of Adobe winning the lawsuit over the Apple, Flash would gain tremendous momentum and the win would propel Flash to becoming the defacto industry standard.
- In the eventuality that Flash becomes the defacto standard – Apple concedes or Adobe wins the lawsuit – Apple would incur a loss in value (hold-up costs, loss in brand equity, loss in market power, and loss of control over Apple apps market)
Utilizing the Payoffs Model
Based on these assumptions, separate models for the payoffs of the two players were constructed. The models are presented in exhibit B & exhibit C. While certain assumptions about the numbers were made for example about the percentage of Apple loyals and loss in value for Apple, these numbers were treated as variables, such as the Flash market share, and tested to see the effect on payoffs. Once the payoffs were arrived at, a sensitivity analysis was run for the payoffs contingent on different values for Flash’s market share, and plotted on graphs to arrive at the best strategies for the two players.
Analyzing the Payoffs
The payoff graphs for Apple and Flash are presented in Fig 4 & Fig 5 respectively below. The graph for Apple’s payoffs clearly indicates a dominant strategy of fighting for market shares of Flash below the 79-80% mark. For market shares of Flash more than this indifference point, Apple is better off conceding with the knowledge that Adobe would in that case always accommodate them.
One of the primary reasons why Apple is still in a good position to fight even though Flash has such high dominance in the online media space is its brand equity. The Apple brand is so strong, and has such a strong customer base, that the percentage of die hard loyal Apple users is high enough for Apple to get. In case the Apple brand equity is lower or the loyalty of Apple customer is assumed to be lower, the slope of the payoffs for Apple fighting reduces. The indifference point (originally at around 79%) then comes down even further, making it rational for Apple to concede even for lower market shares of Flash.
Fig 4: Apple’s Payoffs vs Flash’s Market Share
The graph for Adobe’s payoffs revealed some counter-intuitive insights. Even though Adobe dominates the online media content market with its Flash platform – much more than Apple dominates the mobile internet market – they have very little to no effective power to influence Apple unless they take control of almost the entire market. It is only when their market share crosses the 80% and it becomes rational for Apple to concede, that they exercise some sort of influence.
For most of the other scenarios, we know from Apple’s payoff chart, that they have a dominant strategy of fighting and maintaining the standoff/ban. Given Apple’s dominant strategy, Adobe’s payoffs suggest that their rational strategy would be to fight. Nevertheless the additional benefits from fighting for Adobe are quite marginal. On the other hand, going into legal battle with Apple might have negative repercussions like bad press and publicity, burning of bridges with Apple and negative reaction by other players in the space. Therefore even though rationally it is better for Adobe to fight Apple, looking at the whole picture they might be better off to wait and pursue other soft tactics to get Apple to concede. Having said that, if Adobe could increase their probability of winning the lawsuit against Apple through actions like rallying support from other players/stakeholders in the space, lobbying or ‘bribing’(in the corrupt world), then their expected payoff for Adobe from fighting increases. If the probability increases enough, then the additional benefit to Adobe from fighting might become high enough to warrant such an action, even taking into regard the negative intangibles indicated before.
Fig 4: Adobe’s Payoffs vs Flash’s Market Share
Even though Adobe dominates the market (75% of web videos), they have no effective means to retaliate.
Given Apple’s dominant strategy is fighting (for MS < 84%), rationally Adobe should fight, but the benefits are very small, so it might be better for Adobe to just wait (legal fees, Adobe’s odds of winning if they sue Apple is 10%).
Qualitative analysis of the game
Apple and Adobe were once complementary. In 1990, Adobe purchased Photoshop, which was then exclusively available on Apple’s Macintosh Operating System (OS). This move allowed Apple to survive in an environment that was dominated by Microsoft’s Windows OS. Apple created the computers that creative professionals loved, while Adobe created the software that creative professionals craved.
Today, Apple sees Adobe’s strategy as a threat. The desktop era is stagnating and is being taken over by mobile platforms. Apple is determined to embrace this new market opportunity, to such an extent that Steve Jobs, Apple’s CEO, declared that his company was now a mobile device company when he launched the iPad in January 2010. While Adobe is not a direct competitor to Apple’s trendy devices, it is enabling others to be. Adobe’s vision with Flash, similar to what it accomplished with the pdf file format, is to enable developers to write applications once, using its proprietary tools, and then to run them on any platform, whether it’d be a desktop or a smart phone of any kind. The only problem is that Apple has established a strong brand by “thinking differently”. Losing differentiation is death by low margins. While Adobe’s value proposition is appealing, it completely undermines Apple’s effort to differentiate its products, and in particular the iPhone OS, which runs on the iPhone, the iPod Touch, and the iPad. Apple doesn't yet dominate the smartphone market, and while the iPad is already surprisingly successful, increasing market share and a profitable lineup is far from given.
With competitors like Google, which develops Android (a smart phone OS competing with iPhone OS) and makes it available for free to handset manufacturers such as HTC and Motorola, or Rim, the maker of the Blackberry, not to mention an expected mobile shift from Microsoft and Dell, Apple must attract and retain Apple-focused developers or face being commoditized. (See exhibit D for trend in market share of mobile devices operating software)
Meanwhile, Apple has built a strong reputation. While its original desktop computing business has been lagging behind Microsoft, Apple has radically and lucratively reordered at least three other markets in the past 10 years: music, mobile phones, and recently print. Over the course of 2001, Apple launched the iTunes music software and the first iPod. When the iTunes store went live in 2003, paying for music seemed a quaint idea, but pricing music at 99 cents/song and making it simple to acquire got people in the habit. Today, Apple’s music business represents $4 billion revenues per year (excluding iPod sales).[2]Similarly, since the iPhone first launched three years ago, it has had a huge impact on the industry. Apple’s iPhone was the first touch-focused phone, allowing to pinch-zoom with fingers into maps and web pages. With its app store, Apple was the first to make an application platform that was easy for developers to write apps for, and a store that was easy for consumers to browse, purchase, and download apps from. In 2009, iPhone generated $6.7 billion revenues, making Apple the most profitable mobile company, in spite of having a mere 2.5% worldwide market share[3]. Finally, when Apple recently entered the ebooks market with its iPad, Amazon, the incumbent, was forced to switch from a wholesale model to an agency model.
Apple warned Adobe, but Adobe missed the signal. When Apple first introduced the iPhone in 2007, it made it clear from day 1 that Adobe’s Flash was not supported. Google accepted to re-encode all its Flash videos on YouTube to another format, H.264, which was supported by the iPhone. This move was meant to deter Adobe from trying to enter the nascent platform. Considering that both companies have opposite strategies - Adobe is after a dominant market share while Apple favors high profit margin by cultivating a sense of exclusivity - Adobe should have interpreted iPhone’s lack of Flash support as a warning sign. However, it chose to ignore it and was a victim of the winner’s curse. After dominating the web video market with its technology on the desktop (85% of websites are said to use some form of Flash), Adobe was blinded by its success and failed to see that Apple was gradually locking it out of what is today’s leading mobile platform. Even worse, Adobe wasted tremendous resources creating tools to enable developers to generate iPhone apps, ignoring Apple’s requirements.
While Apple was cautious at first, uncertain of the traction it would be able to generate with the iPhone, it gradually increased the pressure on Adobe following a Brinkmanship strategy, as it sold more devices and applications from its app store - The iphone now has 64% of the mobile browser market[4]. In April 2010, Steve Jobs made it exceedingly clear in a note called “thoughts on Flash”, that Apple wasn’t going to make Flash available for the iPhone, iPod Touch, and iPad, not now, not ever (Apple would promote the emerging web standards instead, called HTML5 and H.264). Ironically, in the process of signaling its position explicitly, Apple even reached cooperation from its rivals against Flash. Microsoft, which has a competing technology called Silverlight, rallied to Apple when Dean Hachamovitch, general manager of internet explorer, wrote on a blog: “the future of the web is HTML5”. In addition, Google, another proponent of HTML5 followed through.