Tim Cook on Vertical Integration and Market Potential

MacRumors published an interesting interview with Tim Cook, Apple CEO. The context was Tim Cook participating in the Goldman Sachs Technology and Internet Conference. The interview questions were posed by analyst Bill Shope. The entire interview is of interest, but I've posted and commented on two specific interactions below where Tim hits upon vertical integration and smartphone market potential (emphasis added by me).

How do we think about Apple's culture of innovation today?

It's never been stronger. It's so embedded in Apple...the desire to make the very best products in the world. It's in the DNA of the company, and so I feel fantastic about it. Now, if you look at some essentials for innovation, there's no formula. But some of the essentials are skills and leadership. If you look at skills, Apple is in a unique and unrivaled position...expertise in software, hardware, and services. Consumers want an elegant experience where technology floats to background and customer is at the center. The real magic happens at the intersection of software, hardware, and services, and we have the ability to innovate and create magic there.

For many year, this idea of "vertical integration" was out of favor. People thought it was kind of crazy, but we never did and we continued to build. This is something you work decades for. I think there are people trying desperately to catch up, and they're finding it very difficult to do.

In terms of leadership, I look around the executive boardroom and see superstars. Jony Ive is the top designer and now turning his attention to software. Bob Mansfield is the leader in silicon. No one better than Jeff Williams at operations. Schiller, Riccio, etc. I've never been more bullish on Apple...we have the talent to pull this off.

IBM dominated the computing world with its vertically integrated mainframe computers. Microsoft and Intel turned that model upside-down in the 80s, with the "Wintel" duopoly. Jumping on for share were companies like Dell, HP, Compaq, Adobe, Lotus, and many more. The shear amount of innovation from all these market leaders put the final nail (we thought) in the vertically integrated model.

Further proof of the paradigm change came from Apple itself that stuck with its vertically integrated model (and shrinking market share). Considerable hope was diminished when Apple announced it would not license its OS to other vendors, and stuck to vertical integration. It wasn't until the iPod, iPhone, and then the iPad that the tides shifted.

Those devices were so successful that Microsoft and Google have recently reversed and jumped into hardware. RIM is also standing a bit taller. But is it really a better model?

The PBX was vertically integrated, but now UC solutions are stuck somewhere in the middle. Many UC vendors only offer software, and many are embracing industry standard SIP endpoints. Consequently, common features like BLF, paging, and park are becoming more complex. In general, SIP interoperability has been a disappointment. On one hand the industry embraces open and software-only -- on the other hand, Cisco, Avaya, Mitel, NEC, SEN, ALU, and ShoreTel all still make their own value-added endpoints. About half of those firms sell virtualized solutions bundled on their own hardware. Interoperability remains somewhat limited, particularly with presence and video.

Question about law of large numbers. Have we reached a natural limit on iPhone growth?

We don't have the word "limit" in our vocabulary. It's because of that that we've been able to do things for so many years and deliver things people never knew they needed. When I look at smartphone market, I see a market that was at 700 million last year...projected to double over next four years. Over the long-term all phones will be smartphones and there are a lot more people in the world than 1.4 billion. And people like to upgrade regularly. This is an enormous market to get to.

We've sold 500 million as of the end of last year, but over 40% of that happened last year. So there's incredible momentum. And we've built a great ecosystem that is also fueling a developer industry..we've now paid out over $8 billion to them. Innovation has all moved to tablets and smartphones, so there's so much momentum. When you look at what we're doing in China, it's impressive. There are also areas where we're not doing as well, and we view those as opportunities. When I string all of these things together, I see a wide open field.

Tim builds his case for a bright future for smartphones (and Apple). I think this is very important and exactly why Blackberry and Microsoft have a chance. Even if innovation completely stopped, people are regularly discovering new uses for their smartphones. Innovation isn't stopping, or even slowing. The market potential for smartphones is huge, don't let anyone convince you otherwise. More on this in a previous post.