Author: Justin Fox

Someday, Apple’s now 11-year-long run of nearly unbroken triumph (I’m dating it to the launch of the iPod in November 2001) is going to end. That is just the way of the business world. The questions, of course, are when, and how.

The mood of the moment is that when might just be now (there are lots of different ideas about the how).

I wouldn’t be so sure that “peak Apple” really is now. What I am pretty sure about is that the how of Apple’s fall (or continued rise) will hinge on strategy — because strategy has driven its success.

How do I know that? Because strategy is all about making choices. That’s what Michael Porter says, and tough-choice-making has clearly been a big part of Apple’s success. Steve Jobs’ revival of the company began with a decision to narrow product lines down to a handful, and its big product successes of recent years have all been defined to a large extent by what Jobs and Apple’s designers decided to leave off. To quote Porter: “Strategy renders choices about what not to do as important as choices about what to do.” If Tim Cook and his colleagues can keep that strategic discipline, the company has a shot at maintaining its competitive edge.

Or actually, maybe strategy is really about finding blue oceans — markets that come into existence as a company defines them. That’s the path to riches described by W. Chan Kim and Renée Mauborgne, and it certainly sounds like what Apple has been up to. With the iPod/iTunes combo, the iPhone, and the iPad, the company has repeatedly given customers something that felt entirely new, that solved their problems in a way no existing product did. Now the competitive sea is getting more crowded, especially for iPhone. Apple still has an edge, in that it built that sea — “so powerful is blue ocean strategy,” Chan and Mauborgne write, “that a blue ocean strategic move can create brand equity that lasts for decades.” But you have to think that, to really stay on top, Apple needs to find more blue oceans to conquer. Which is a lot easier said than done.

Then again, maybe the real key to strategic success in the fast-moving fields Apple is playing in is to keep coming up with disruptive innovations &#8212 and be willing to bring them to market even when they disrupt its own products. That’s Clayton Christensen’s famous contribution to strategy, and you can certainly see elements of it in Apple’s story. True, none of the company’s three huge successes of the past 11 years (the iPod, the iPhone, and the iPad) really fit Christensen’s classic disruption model of starting at the low end and moving upmarket. Christensen even said back in 2007 that the iPhone “was not truly disruptive” and probably wouldn’t succeed. But it does seem reasonable to argue that a continued willingness to disrupt itself will probably be key to Apple’s continued success. The iPhone has cut into iPod sales, and the iPad is hurting the iMac, and Apple seems okay with that. Microsoft, meanwhile, killed its promising Courier Tablet three years ago because of fears that its incompatibility with Windows and Office would disrupt those money-spinning franchises.

Of course, modern technology businesses have some other unique strategic characteristics. One is a tendency to move from integrated products controlled by a single company to modular ones with interchangeable parts. This is another Christensen observation, albeit a lot less famous than the one about disruptive innovation. “The companies that are most successful in the beginning are those with optimized, interdependent architectures,” he and Michael Raynor write in The Innovator’s Solution. “Later, architectures and industry structures will evolve toward openness and disintegration.” In the beginning the integrated solution delivers better value; later, lower costs and the ability to customize favor the modular approach. This was apparent with both of Apple’s early blue-ocean-creating disruptive innovations, the Apple II and the Macintosh, as the modular, relatively open PC architecture pioneered by IBM and later dominated by Microsoft and Intel eventual came to dominate markets that Apple created.

Microsoft’s rise was also abetted by two other sources of competitive advantage: network effects and switching costs. A network effect transpires when the value of a product or service grows with the number of users; switching costs are just what they sound like. “The old industrial economy was driven by economies of scale,” Carl Shapiro and Hal Varian write in their digital-age strategy guide Information Rules. “The new information economy is driven by the economics of networks.” In the early 1990s, the modular nature of the Windows PC made it cheaper and more customizable, and as its customer base grew far larger than the Mac’s it became more valuable for most customers, too. That was partly an indirect network effect — Windows’ many users made it a more attractive platform to write software for, and all that software made it more valuable to users. And it was partly a direct one — having compatible software made it easier for all those users to share documents, collaborate, etc., which made the Windows platform more valuable to them. And once you had invested in all that software, it was a real pain to switch from Windows to anything else. Not that you wanted to. By 1997, when Steve Jobs came back to Apple, Windows computers were demonstrably better in almost every way than Macs (I know from experience; I had a crash-prone Mac at work and a reliable PC at home). It took the unreasoning loyalty of the Apple faithful, continued superiority in (and high switching costs for) graphic-design software, and a lot of help from Microsoft to keep Apple alive long enough for Jobs to stage a comeback.

In its second coming, Apple has been smarter about exploiting network effects (the iTunes store and the app store take advantage of indirect network effects, while Face Time and iChat take advantage of direct ones). The sheer convenience of using all its products together also creates very real switching costs — the 250 million people now using Apple’s iCloud are going to think twice (or three or four times) before buying a smartphone, tablet, or computer from anybody else. But Apple is now being threatened by a set of lower-cost, modular competitors that look a lot like Microsoft and Intel back in the day. Devices from Samsung, HTC, Coolpad, and lots of other manufacturers using Google’s Android operating system now account for 75% of the global smartphone market. The numbers of apps and games available for Android devices caught up with Apple’s App Store total late last year, and will surely now surge far ahead. Despite the superior design and user-friendliness of Apple’s devices (not to mention those stores), network effects could soon be delivering better value for most customers than Apple’s sleekly integrated approach (maybe they are already). To circle back to Porter:

A company can outperform rivals only if it can establish a difference that it can preserve. It must deliver greater value to customers or create comparable value at a lower cost, or do both.

My own reading of all this strategic wisdom is that unless Apple ventures out onto some more blue oceans with disruptive innovations and hard choices, it’s going to find itself fighting a long and eventually unsuccessful war against its modular competitors and their powerful network effects, although switching costs will at least buy it some time.

Another takeaway might be that strategic thinking inevitably leads to mixed metaphors. The business world is just too complex to fit comfortably into any one strategic model. Porter’s seems the most flexible and durable of the lot, but that’s partly because it’s a tool more of analysis than of prescription or prediction. I spent a little while trying to plug Apple’s situation into his five-forces framework, and while it made some of the company’s choices clearer to me, it certainly didn’t tell me what’s going to happen next.

The language of strategy is, however, more informative about Apple’s predicament than most of the chatter one hears about whether the company is still cool or Tim Cook really has what it takes. I’m a fan of Amar Bhidé’s anti-strategy polemic, “Hustle as Strategy,” in which he argues that many of the most successful companies “concentrate on operating details and doing things well. Hustle is their style and their strategy.” But while a failure to hustle could surely doom Apple, its challenge now may be that hustle alone won’t be enough to keep it on top of the world. Then again, it looks as if the surest path to continued success for the company involves coming up with yet another market-defining success along the lines of the iPod, iPhone, and iPad. I’d like to see a strategy professor do that.

A couple of disclaimers: I do not profess to be strategy expert; thinking about Apple just sent me to my bookshelf and HBR‘s archive in search of answers. And I really didn’t mean for this to be a promotional post for HBR and the HBR Press; I just happened to consult the work of a bunch of our authors because (1) it was convenient and (2) we publish most of the best strategy thinkers. Or at least we think we do.

There are a couple of fundamental questions at the bottom of Washington’s ongoing battles over deficits and debt: (1) How big should the U.S. government to be? and (2) How should we pay for it? The answers to both will ultimately have to be political ones — messy calculations based on who pays, who benefits, who votes, and who makes the campaign contributions. But it would be nice to know what the economics are, wouldn’t it?

It turns out economists have lots of theories of optimal government spending and optimal taxation. This isn’t the same as saying they have reliable or consistent answers. As one critic wrote of Robert Lucas’s American Economic Association presidential address on economic growth in 2003, in which the Nobel laureate cited several studies showing dramatic welfare gains from hypothetical tax cuts in France and the U.S.:

Such findings have two distinctive features. First, they show big numbers. Second, they are not really findings. Contrary to the words offered so traditionally and casually by economists, none of these authors actually ‘found’ or ‘showed’ their results. Rather, they chose to imagine the results they announced. In every study Lucas cited here the crucial ingredient was a theoretical model laden with assumptions.

The author of these words is University of California, Davis economic historian Peter Lindert, who hid them among the data appendices in volume two of his epic 2004 empirical study, Growing Public: Social Spending and Economic Growth Since the Eighteenth Century. The books have developed something of a cult following among econowonks across the political spectrum. People on the left love Lindert’s conclusion, contained in this shorter working paper, that the rise in spending (and accompanying taxation) has not carried with it the costs predicted by neoclassical economic theories such as the ones wielded by Lucas. But those on the right love his explanation that this is mostly because countries with high social spending have tax systems that appear to have been designed by a neoclassical economist: with low progressivity, low taxes on capital, and big value-added taxes on consumption.

Lindert found essentially no correlation between levels of social spending (expressed as a percentage of GDP) and economic growth in wealthy nations in the post-World War II era. During the first big rise in social spending, from 1880 to 1930, there was actually a positive correlation — probably because early poor-relief measures improved workers’ health and productivity. Lindert thinks social spending on health-care and education can still have positive growth effects — and of course government infrastructure and R&D spending, which weren’t a focus of his study, can boost growth as well. But his main takeaway was that the Swedens and Germanys of the world have a “more pro-growth and regressive mix of taxes” (italics LIndert’s) than lower-spending nations such as the U.S.

So basically, the frequent Republican contention that high government spending is choking economic growth in the U.S. isn’t really backed up the evidence — at about 42.5% in 2010, government spending’s share of GDP in the U.S. (that includes state and local spending) is on the low side among the world’s wealthy nations. But at the same time, if spending is to go higher, or if we simply want to be able to pay for the spending we’re already doing, the Democratic focus on raising taxes on the wealthy isn’t going to get us there.

Which brings us back to the political discussion in Washington. Republicans have for the past couple of years been going with the mantra that federal spending should be brought down to a “historical average” of 18% of GDP. Since World War II, federal spending has actually been closer to 20% of GDP, but tax revenue has averaged just under 18%, so that is a reasonable starting point (if you go back farther in history, you can of course get it much lower, but it’s not clear what that proves). It’s also possible to run ongoing deficits of 1% or 2% of GDP without major ill effects — as long as the economy grows fast enough and interest rates are low enough that the federal debt shrinks as a percentage of GDP.

The question is whether it’s realistic to think federal spending can be kept to 20% of GDP (or wise to think it should). Right now it’s at 24%, and while that will decline as the economy continues to recover, the retirement of the Baby Boom generation is going to put upward pressure on spending for decades to come. We’re also going through an era of economic and technological upheaval that probably calls for increased investment in education and research, and may even justify increased social spending. So it’s perfectly reasonable to argue that spending, and taxes, will have to be higher going forward.

As Peter Lindert’s research shows, this wouldn’t have to hurt economic growth. But as his research also shows, it really can’t be done just by raising income tax rates on the wealthy. The U.S. already has about the most progressive income tax system around. European social democracies tend to have flatter income taxes, plus value-added taxes that hit all consumers. They tax capital gains and dividends at lower rates than regular income, just as the U.S. does, but they also all have lower corporate tax rates than the U.S. This lack of progressivity extends to the spending side: Lindert says social programs are less likely to be means-tested in the big-spending social democracies than in the U.S. or Great Britain.

The economic logic behind all this is that progressive tax systems and means-tested social programs can carry with them big disincentives to work, particularly near the bottom of the income scale. As for the low taxes on capital and corporate income, that’s partly neoclassical theory (by encouraging investment, you get more growth) but also just realism about enforcement (global corporations and investors can easily get around such taxes).

This lesson has sunk through to budget experts like Alice Rivlin, whose original deficit-reduction plan with Republican former Senator Pete Domenici included a value-added tax. But it has so far been political poison: Republicans hate any talk of new taxes, and Democrats hate any talk of regressive new taxes. If the U.S. is going to make it safely through the budget challenges of the next few decades, though, both parties are going to have to get over their phobias.