Priorities in a time of plenty

How Apple is managed is one of its enduring mysteries. The idea that a company with $235 billion in sales is managed with a single P/L[1]  is fascinating in many ways. Not least of which is how it allocates resources. The fundamental question of which great idea gets to be funded and which great idea gets to be ignored is the core of every manager’s dilemma. The Apple problem is at scale  when each decision’s consequences are so momentous. In the case of Apple there are so few projects that reach the market and their impact is so great that one wonders how they can be sure they are doing the right thing.

Conventionally, product development is filtered through a sieve of  metrics, market sizing and impact on top/bottom income lines. These “financial” measures of success are considered prudent and optimized for return on equity (also known as the maximization of shareholder returns).

But this can be a toxic formula. The financial optimization algorithm always prioritizes the known over the unknown since the known can be measured and is assigned a quantum of value while the unknown is “discounted” with a steep hurdle rate, and assigned a near zero net present value. Thus the financial algorithm leads to promoting efficiency at the expense of creation. Efficiency may be the right priority when times are difficult and resources are scarce but creativity is the right priority in a time of plenty. And abundance is what being big is all about.

To allow for some creation large firms create divisions. Some divisions are tasked with “core products” which are measured by a set of firm metrics and some are tasked with “emerging products” which are given a set of loose metrics. This leads to obvious resentment and war between divisions when resources need allocating.

Ominously, the core divisions tend to always win. At the root of divisional power struggles are measurements–the roots of financial metrics. Managers fight with data. “You can’t manage what you can’t measure” they’re taught. But if you have something that can be easily measured and something that is difficult to measure, won’t the easily-measured be managed and the hard-to-measure be ignored?

There is a general principle at work here: Managing by measurement is fraught with the pitfall of measuring the wrong thing. Making sure that you’re measuring the right thing becomes the value-adding role of the manager. A role that is increasingly being neglected.

The mass phenomenon of measuring the wrong thing because it’s the easiest to measure is called “financialization”. Financialization is the process by which finance and finances (rather than creation) determine company, individual and society’s priorities. It comes about from an abundance of data that leads to fixation on what is observable to the detriment of awareness of hazards or obstacles or alternatives. This phenomenon is more likely when the speed of change increases and decision cycles shorten.

Financialization is creeping into all aspects of society and the extent to which it infects companies is the extent to which they suffer from early mortality.

So is Apple avoiding financialization? How can anyone avoid the tyranny of mis-optimization?

The unified P/L might be a clue. It obviates the need for divisional rivalry and power-based or financial politics. Without divisional P/L, management can be organized functionally with the obvious benefit of de-politicization. The singular P/L does create another problem however: the absence of an alternative resource allocation algorithm centralizes the decision. By centralizing decisions at the highest level, few decisions can be taken and that means each decision has to be right more often. We swap a distributed but financialized process for a central but capricious one.

So how is the central decision process made fair? What guides the allocation process?

I believe that Apple does not avoid quantified decision making. I believe the logic of their decisions is based on a nuanced quantification of the company’s customer base. Opting to think about how many customers they have rather than how many things they can sell could offer the Apple manager a better decision tool, avoiding financialization and mis-optimization.

The guiding principle is putting the customer rather than the firm at the center of the decision process. The idea of this change of orientation extends to a re-definition of the purpose of the firm. Apple calls it its “North Star” and it places “making the best product” at that location.

The challenge is how to measure “goodness” of product. It’s easy to overshoot “best” and become too good. What regulates greatness is another measurement: absorption of what you create. The true orientation (which Apple won’t confess to) is absorbable greatness.

Absorbable greatness is measured through other proxies: customer creation, customer satisfaction, and customer retention. By adding and preserving great customers you can be sure that what you create is indeed the “best”. Setting the goal, and indeed the purpose of the firm, as the creation and preservation of customers seems to be the unwritten constitution of Apple.

The idea that the purpose of the firm is to create and maintain customers is not new[2] but it is relatively rarely practiced. The reason is that the data is harder to obtain. The data that comes from sales is crisp and concrete. The data about customers is muddy and soft. In a world where spreadsheets are used as weapons, the crisper the data, the better the ammunition.

Clarity wins arguments but it may not be where salvation or truth can be found. Good judgement in a cloudy reality is a better compass than a clear road map to a fantasy world.

Optimizing around customer acquisition rather than equity returns leads to a new set of metrics. What would these metrics look like for Apple?

The company publicly offers three separate sets of quantity of customers and quality of customers.

In terms of quantity we have:

  1. Number of iTunes accounts
  2. Number of iCloud accounts
  3. Number of active devices

In terms of quality of customers we have:

  1. Average selling prices for devices (as a proxy for willingness to pay)
  2. Customer satisfaction (as a proxy for loyalty )
  3. Services and accessory revenues (post-sales and recurring value)

The following graph shows the historic data for service accounts and corresponding services revenues.

Screen Shot 2016-02-16 at 2-16-11.04.50 AM

The following graph shows the average price per hardware product indicative of loyalty through stability in the face of growing competition.

Screen Shot 2016-02-16 at 2-16-1.08.35 PM

The following graph shows an estimate of growth in active devices as a proxy of customer base.

Screen Shot 2016-02-16 at 2-16-1.02.58 PM

Unlike product shipments and revenue data which follow rises and falls in individual products due to the cyclicality of technology and adoption, these graphs show a smoothness and predictability of customer base behavior.

Looking at Apple this way gives the impression that the company has a large number (nearly a billion) of repeat (subscribed to service) customers. These customers can be seen to spend a predictable recurring amount (average selling price) on Apple’s brand. The repetition of these metrics in public commentary suggests that customer acquisition and retention are among Apple’s goals.

The key question is whether this is Apple’s primary goal.

Seen this way each centralized resource allocation question can be assumed to be prefaced with “In order to create/preserve customers should we…?”

This leads to answers quite different from questions that start with “In order to sell/profit more should we…?”

For instance, offering education products, retail store experiences, healthcare products, green energy initiatives, accessories, content and services make sense even if they may have poor financial “returns”. These initiatives score highly on customer retention and satisfaction. They may lead to engagement and repeat sales. Managers working on these initiatives would gain the respect of their peers, leading to more esteem and higher quality output. Finally, and most importantly, these efforts would be preserved regardless of cyclical downturns.

The assessment of analysts should therefore be couched in similar terms: “What is the impact of a new initiative in customer creation and preservation?” rather than “What is the impact of a new initiative in driving revenues and profitability”.

We can see immediately why the second question is popular while the first isn’t: it’s easier to assess an answer to the second because we have the data that allows for its calculation.

This is why asking the wrong questions is popular.

It’s not cynicism. It’s access to data.

  1. Profit and Loss statement is an income statement usually applied for a subset of a larger company which allows subdivisions to be managed individually. []
  2. Customer creation is in contrast to the notion that the purpose of the firm is to maximize shareholder returns. The notion of customer creation as primary purpose was popularized by Peter Drucker. The notion of optimization through shareholder value creation was popularized by Jack Welch. []
  • Vincent Touquet

    John Kay in his book Obliquity touches upon how great companies are when they assume an oblique strategy, meaning they do not chase financial returns directly, but obliquely. The cemeteries of the world are littered with companies who started focusing on shareholder return only. See:

    • WFA67

      Thanks for this term and concept.

      “As Kay says, no one will be buried with the epitaph ‘he maximised shareholder value’.”

      • Vincent Touquet

        Exactly 🙂

      • With the footnote that “All such maximization is local.”

    • art hackett

      I strongly suspect this current obsession with “shareholder returns, for the shareholder, etc” for the last 15-20 years, is a convenient smokescreen for con artist CEO’s and/or boards to milk a previously productive business of future earnings and growth, and award themselves obscene bonuses and platinum parachutes when the enterprise collapses.
      There are, as you say, company graveyards filled with once mighty businesses that somehow became “shareholder focussed”.

  • I see the dichotomy of management as the difference between strategy and tactic.
    Apple has strategic goals that if rightly pursued will lead to more income, while managers focusing on return make tactic decisions without a longer period view, and often those decision comes at a detriment of future income.
    A great firm should have great strategic managers at his core and great tactic managers that execute without financial burden.

  • Bernard Desarnauts

    Horace, I really dig this one ““What is the impact of a new initiative in customer creation and preservation?” it really sums it super well and maybe you can integrate in that thought the disruption/self-disruption theory… iPhone disrupting iPod, etc?

  • Panos

    I can see the correlation, i cannot really get the causation (yet).
    You need “different” data. You need your “LIGO Lab”.

    • What is a LIGO lab?

      • charlesarthur

        LIGO stands for something like Light Interferometry Gravitational Observation. It’s the paired labs which measured gravitational waves, where you needed two identical labs separated by distance to remove chance local events.

      • Panos

        What i am trying to say,metaphorically speaking, is that sometimes (like in the detection of the gravitational waves), in order to approach unconventional phenomena you might need unconventional methods/data.

      • Walt French

        To amplify on your fine analogy, the gravity wave experiment cost about a billion dollars because despite the undeniable importance of gravity, the ripples caused by its waves moved objects on earth a tiny fraction of an atom’s diameter.

        IOW, incredible resources were expended to understand a HUGE phenomenon that was otherwise utterly invisible to us. Apple’s magic appears similar.

  • Juil

    Thank you for the time you took to clearly articulate those thoughts Horace. I had lingering thoughts similar to yours, but you succinctly (well, more succinctly than me;) expressed them in a way that highlights Apple’s pretty unique hierarchy outline (compared to most other “behemoth corporations” anyways).

    I think there is also something to be said about seeing Apple’s products as fitting in various “computing form factors” in relationship with humans, instead of the product categories that the marketing research firm peddle. i.e. desk/fixed computers, transportable computers, mobile computers, pocket computers and now wearable computers [>] Tower PCs, laptops PCs, tablets, convertibles, mobile phones, smartphones, smart watches and so forth.

    So with that in mind for example, Apple never “cannibalized” the iPod with the iPhone, they just drastically updated the pocket computer lineup that they had (that up until that point had been reduced to mostly just music/video playback). Anyways, just a thought I throw out there…

  • hannahjs

    I’m confused…near the end you said it’s easier to assess an answer to the FIRST question (customers) than the SECOND (profits). Didn’t you mean it the other way round?

    • claimchowder

      Pretty sure he did, yes. Stuff happens.

      • matt

        i think he meant it as he wrote it. the first is easy because of horace’s model that shows you customer retention etc… is supported by available data. meanwhile the financialists and analysis-ists and pundits would rather ask the second question and posit answers because there is no clear answer in the short term. but few seem interested in what is so readily answerable (ie. the first): that apple are and continue to be quite successful at customer creation, retention & satisfaction because they are asking this when choosing to allocate resources.

    • Sorry about that. It should read as “it’s easier to assess an answer to the second because we have the data that allows for its calculation”

  • WFA67

    Thanks so much, Horace. This is an avenue of inquiry into Apple culture which, as in your recent podcast, explores (and for me affirms) the strength of a company faced with the organizational and cultural challenges of increasing scale.

    The question, “Just what is it that we are doing here?” really sets a trajectory. And can make a huge difference in motivation, performance, and job satisfaction.

    Am looking forward to more on this subject, especially if sourced from any on the inside.

    Also, the question of transferability of Apple values outside the company is an open question. See the current criticism of Tony Fadell of Nest.

    • I would not expect any sourcing “from the inside”. Aside from the policy of non-disclosure these priorities are not necessarily explicitly stated. This is why I consider this an unwritten constitution.

  • Walt French

    Horace—First, thank you for this very helpful effort. I wouldn’t have been able to express concerns without your lead.
    Apple cites a couple of other numbers: the count of Android switchers and upgraders come to mind.
    While the number of switchers addresses relative satisfaction, the other has been used to signal the future opportunities, assuming all the loyalty they (and you) cite. But frankly, they trouble me because the fact that they are reported selectively in mandatory shareholder discussions allows Apple to use them as a “put your best foot forward” exercise, rather than helping investors gain a balanced view. They serve to “sell” Apple’s success story to shareholder. A sense of momentum is very helpful for sales, but I like other ways of helping shareholders get a sense of the company’s use of their assets.
    That leads to my central concern: your description is almost precisely what we would want Apple—really, ANY company—to be doing, and it’s hard, as you say, to distinguish this ideal from many other explanations. Those others range from randomness (Apple stumbled onto a capability at exactly the right moment), to skeptical (the company worships Jobs so much they retain his idiosyncratic methods) to worse. In my mind, your explanation is most consistent with what I see but not exclusively or entirely so.
    Choices such as the Beats acquisition inevitably must have seemed a zero-sum game by many groups within Apple, just as Mac users had to get used to the new baby in the family getting all the attention. Maybe Beats was the best way to grow/retain a certain group of customers but its timing right near Peak Streaming sure looked like about the worst possible for those results.
    This and many more doesn’t mean Apple doesn’t work as you describe but it DOES highlight that with selective reads of data, an unknown political structure and challengeable decisions make it difficult to see how well Apple’s process really works…AND to see what it really is.

    • KirkBurgess

      Not sure how the beats acquisition belongs in this discussion. To me if fit in with the dozens of other acquisitions Apple makes every year to acquire talent & technology that furthers its effort to create and retain customers.

      • Walt French

        Of course we will continue to want music, but the Beats deal comes as the existing music industry has become more-or-less a shambles. Even the streaming firms that pay virtually nothing to artists are struggling; I would expect consolidation that may result in more clients for Apple’s Music services—but how that translates to a service that many people find valuable is far from obvious.

        So Apple Music almost appears as the antithesis of the main argument.

        I’ll grant that I have personal tastes ill-served by Apple and other services. (I only recognized 3 artists’ names from a list of 15 albums that made various Top10 Album lists.) But with worrisome news about Spotify and Pandora, it’s not clear that Apple is going to ride in and rescue the mid-20th-century industry/mindset from the 21st century tastes and financials.

      • handleym

        With the Beats purchase are you buying
        – a set of headphone designs OR
        – a list of “leads” (pre-existing streaming customers) OR
        – a set of rights/agreements (some formal, some informal) to use content in certain ways, now and in the future.

        It’s possible, even likely, that the essential part of the purchase was the third item, but that’s not visible right now; all that’s visible is the somewhat botched launch of a new Apple service. I expect the service (and related issues — various complaints about the iOS Music app and so on) will be resolved over the next year or two; but the real issue may be the rights and agreements if they, for example, allow Apple to use music in unexpected future ways that are only just being worked on.

        (For example, how might one use music in VR environments? Could one have a personal associated tune like a ring-tone, a musical version of one’s avatar? I could imagine this being the sort of thing that could be destroyed in its infancy by music industry stupidity and greed — like happened with ring tones — but not if Apple has the rights in place to do a competent job.)

    • Panos

      I totally agree. As already said, I can see the correlation, I cannot get the causation.

      But let me elaborate more.

      In Horace’s current post there are two parts.

      One is the theory, and the other is the observation (Apple).

      However I don’t really see what comes first, the observation or the theory? Either way different problems might arise.

      If the observation precedes theory there could be different issues. E.g.: What you observed, how/what method, why you choose to observe this over the other, how you interpret the results, is there any bias etc. However the most important issue, is not to fall victim of the induction problem. That is, to believe that a confirming observation over some companies’ behavior, verify universal generalizations.

      On the other hand, if the theory precedes the observation, dealing with one/some company that usually verifies the theory does not make any sense. Instead, someone should focus in making the theory clear and robust enough so that can be applicable (verified or even better rejected) to different cases, by different users.

      Regardless, I admire his thinking and I learn a lot reading his blog.

  • boghall

    Reminds me of a favourite saying of one of my old professors (often in answer to ‘hard’ physical scientists who accused ecological, ‘systemic’ thinking of being based more on emotion than ‘facts’): ‘Absence of evidence is not evidence of absence.’ Pretty close to Alfred North Whitehead’s ‘fallacy of misplaced concreteness.’ How different capitalism (and the world) might be if enterprises placed as much emphasis on managing some of these customer attraction/retention metrics (and even reporting them) as on the finances.

    • The thesis of “The Capitalist’s Dilemma” suggests that the emphasis on financial performance is a relatively new phenomenon. It might be traceable to academic work from the 1970s. Prior to the use of spreadsheet WMD (Weapons of Management Destruction), decisions had to be made on bases other than data and ROI/ROE.

  • Sacto_Joe

    Reading this, I feel like an old prospector who’s down to his last few gulps of water when he comes at last on a cool, clean, bubbling spring. Thanks for posting.
    You hit the nail on the head. As I said on PED’s site yesterday, cash and margins are not the prime drivers for Apple’s business. Apple’s prime driver is service to it’s customers. The cash and high margins are merely natural byproducts of Apple’s devotion to service. I’m convinced this is the “secret sauce” that Steve Jobs instilled deep in Apple’s culture.

    • Thanks. It’s a subtle distinction in priorities, but an important one. The survival of the firm depends on understanding the causality of its success/failure. Too often we associate the outcome (financial performance) with optimization because we gain something from a marginal improvement. We gain a tiny amount of profit from an efficiency but we don’t gain preservation or unforeseeable growth. This is at the core of a great organization: a balance between optimization and creation.

      • Walt French

        “The survival of the firm depends on understanding the causality of its success/failure.”

        Where have I heard that before? 😄

        Speaking of Asymco as a brand, it consistently delivers.

      • Sacto_Joe

        Speaking of devotion to service, I can see that as well in Apple’s recent stand in defence of privacy. Cynics might see it as self-serving, especially on the international stage (the Chinese market in particular). But it was, and remains, a risky ploy. I believe that the most logical explanation for taking such a risk is Apple’s devotion to service.

      • ThinkActive

        And let’s remember that Apple as people and individuals want to make the devices that they would want to use.

        And if they do indeed use them (!) imagine the ease of industrial theft were the iPhone backdoor to become a reality.

      • Sacto_Joe

        An excellent point! By destroying the security of Apple’s devices, the government is, in essence, asking Apple to risk harming itself irreparably.

  • jbelkin

    Apple’s success has been built upon a simple premise – how can we make your life easier. Apple then tries to design the nicest and easiest to use product/service to deliver that. That seems simple but if you stay focused – you get it done? Apple’s worst years? Their company focus became instead of how to maximize profit and they became another company. But fortiunately, SJ came back.

  • WFA67

    I rather like this apocryphal tale:

    A medieval traveler comes upon a quarry where he sees men working. Walking up to one of them, he asks, “What are you doing?” The surly worker responds, “Can’t you see I’m hammering a stone?” Moving along, the traveler comes on another worker, of whom he makes the same query. This man responds, “What do you think I’m doing? I’m earning a living!” Approaching yet a third man, the traveler asks him, “And what is it that you are doing?” This man looks up at him and says, “Thank you for asking, sir. I’m building a cathedral!”

  • Matt Ballantine

    It’s a strong analysis, Horace. Thanks.

    One question it springs for me is will focus on customer wane over time? There are a couple if social science “laws”- those of Goodhart & Campbell that express challenges of goals becoming numbers: firstly that the meaning of the numbers change, and secondly that people game things to hit them. So over time mechanisms get put in place specifically to drive the metric, rather than decisions being made where the metric is a barometer of success. One sees this a lot in other organisations with things like net promoter score.

  • Oblomov

    Another strong post, Horace. One interesting footnote is that, at least anecdotally, The Innovator’s Dilemma was one of Jobs’ favorite books. We will never know for sure, of course, but it wouldn’t be a surprise to see it on Apple University’s reading list. Perhaps, rather than LIGO and general relativity, quantum mechanics would be a better analogy in that the act of observation affects what is observed and, in this case at least, to great effect.

  • berult

    Moving the topic’s center of gravity towards realpolitik…

    Apple’s mission statement: “To leave the world…a better place than we found it”;

    for the institution of Government, this means: “To insure perennity for the King, by front-loading its Pawns, and when necessary, by gambit of its Queen on down to its Rooks, Bishops, Knights, and Pawns”,

    for the institutions of commoditization, this means: “To leave the world…a cheaper place than we found it, and we…proportionally richer, and deservedly so, for having made life into an affordable, and as a bonus to us…the power that be, a lifeless commodity”,

    for the institution of Homo Sapiens (the concept of the sanctity of the human soul), this means: Privacy tempers “We, the People…”‘s Security in as much as the Liberal Arts diffuse judiciously creative usage of technology.

    All three institutions attract, two of them abstract, one of them contracts I…into We…

  • handleym

    “Looking at Apple this way gives the impression that the company has a large number (nearly a billion) of repeat (subscribed to service) customers.”

    Looking at all the graphs in total, I think the iCloud accounts number (800 million) is probably the best proxy for actual users.

    The 1 billion devices, I think, corresponds to the large (and probably growing larger every year) number of people with two or more Apple devices. I’m actually surprised that it’s THAT low; testament to how many people own ONLY an iPhone — and are, one suspects, likely buyers for a Watch (once that’s become a device with clear use cases and is past the initial hardware and software issues), an iPad, maybe even a Mac.
    Could Apple sell a $600 Mac Lite to these people? (Plastic case, older CPU, slower SSD? Maybe we’ll see some thinking about that issue once the mythical ARM Mac is released, and Apple has more total control of the box without having to match Intel’s ideas regarding segmentation and cost — cf the iPhone 5c, and the 5se…)

    The 900 million iTunes accounts, I suspect, includes around 100 million one-time iPod users who, one way or another, migrated to mostly Android with a little Win Phone thrown in, people who were never really in the Apple camp but who bought an iPod to connect to their Windows boxes when iPod was really the only usable digital music game in town.

    • ThinkActive

      Many people choose to share an Apple ID remember..

      • Kizedek

        I was thinking that, too. But it’s a tricky one…

        I would say you can bank on many iTunes accounts being shared — i.e., iCloud accounts with credit cards attached. Many families, such as mine, use only one or two iTunes accounts for the whole family. But, each individual with a device has their own iCloud account (perhaps linked under Family Sharing), to handle their own mail account and personal bookmarks, calendars, etc.

        So, here, the article quotes iCloud accounts.
        Other times, Credit Cards are counted.
        Both are variously mentioned by Apple in quarterly earnings calls.

        Generally, I would say the number of “Credit Cards” is lower than the number of “active iCloud Accounts”. Just as the the number of households represented is lower than the number of devices present in those households.

        Having said that, however, I am pretty sure Horace has elsewhere said the number of Credit Card accounts for Apple is on the order of 800M to 1B.

  • kmadsen

    Thanks Horace – Considering the RPV theory (focused on Values), are you suggesting that the single P/L and therefore “each decision has to be right more often” poses a risk? The risk being that focus will shift from customer/product to profit? It seems that Values are so strongly ingrained with Apple that this risk is very small.

  • Steve Jobs in 1997 on Apple’s secret weapon, the customer experience: