The ocean is riddled with raiders
Who hassle legitimate traders
But lo and behold!
We can keep our gold
If we just out-design the invaders!
What if I could show you how Apple (NASDAQ:AAPL) is getting the best of hardware pirates, simply by being the best Apple it can be? And the same principles can work for many other businesses, too.
The piracy problem
Piracy is a major problem for several industries. In Hollywood, movie studios and TV networks are trying to find a mix of consumer-friendly, salable content packages and hard-nosed copy protection measures that can squeeze cash out of content libraries like Disney's (NYSE:DIS) and Time Warner's (NYSE:TWX). The Motion Picture Association of America released a study in 2005 that put major studios' yearly worldwide losses due to piracy at $6.1 billion. China’s piracy rate stood at nearly 93%. Unlike other industries which count on the emerging world for future expansion, piracy takes the “oomph” out of any potential Hollywood-worthy growth story.
The music business sits in a similarly uncomfortable position. Ubiquitous MP3 downloads from legal and illegal sources are threatening to make zero-cost commodities out of our favorite songs, albums -- even artists.
Software wranglers have been fighting the pirates since, well, the beginning of software development. Despite their best efforts, even veterans like Electronic Arts (NASDAQ:ERTS) and Microsoft (NASDAQ:MSFT) often find their latest and greatest programs available for free download -- before they even hit store shelves.
In a 2008 study, the Business Software Alliance calculated that the global piracy rate was 38% and resulted in more than $48 billion in packaged PC software losses. In the emerging BRIC countries, more than 75% of all software is pirated rather than bought, according to this data.
And the problem extends even to consumer electronics and other hardware. Design a better mousetrap and watch Taiwanese or Indonesian knockoffs flooding less-reputable markets everywhere within weeks. It happened to Apple's iPhones and iPod Nanos already. TiPhone, anyone?
The stylish solution
But now, Apple may have found a cure for the disease of hardware piracy in an unconventional way. High-end design has always been a hallmark of Apple -- lithe, svelte, handy-dandy gadgets in smoothly stacked shells. You know an Apple gizmo when you see it. And Apple has finally gone so far as to out-design the pirates.
The latest iteration of the iPod Shuffle is so ridiculously compact and efficient in design that would-be copy shops just can't pull off the usual cloning job. The Shuffle's basic components, like resistors and capacitors, are too tiny to even identify. The rechargeable battery may be the smallest model available anywhere. Each part may be rather inexpensive -- iSuppli sees a hardware bill of just $21.77 for the $79 Shuffle -- but they're also impossibly small and hard to handle.
It appears at this point that Apple has out-designed the pirates stalking its wares. By the time the hardware pirates catch up to this ultra-compact manufacturing move, Apple will have had plenty of opportunity to increase its lead with new designs. I wouldn't bet against it.
How other companies can beat their scourges, too
Each of the old-line media dinosaurs already has its own formidable array of unique weaponry available. The movie industry has larger-than-life screens and the old dinner-and-a-movie angle, neither of which is easily copied by your home theater system.
Longtime Rule Breakers recommendation IMAX (NASDAQ:IMAX) tackles the dual threats of piracy and commoditization by producing a movie-watching experience that quite frankly can't be copied and taken home. I mean, who installs a home theater that covers your entire field of vision, with surround sound to match?
IMAX is not profitable today, as the focus now is on rolling out new theater installations -- which will pay dividends later on, as the screening fees start to rack up. And IMAX has a technological lock-in that guarantees that no third parties will butt in with unapproved content. The piracy problem can be countered in part with tools of the trade and by adoption of progressive technology.
Enterprise software traditionally comes with large price tags, but open-source specialists like Red Hat (NYSE:RHT) are proving that you can make money in other ways. Anybody can download Red Hat's core software for free -- and the kernel it’s based on is open-source, meaning all users have access to the core it runs on. In other words, software pirates have no reason whatsoever to make copies on the sly. Red Hat and its peers make their money by designing installation packages, providing business-class tech support, and offering other high-value services that tie into the software they're making. And sure, you can start your own Red Hat consulting outfit -- but nobody knows the software quite like Red Hat does.
What savvy investors should know
Although piracy is a salient threat to intellectual property of all kinds, investors can structure a portfolio that’s defensive against its effects -- or even one that profits from them.
Apple is fighting piracy with design. Red Hat does an end-around with high-quality support services. IMAX is applying unique technology to a familiar industry, locking customers into a long, profitable stream of film licenses.
The fact is, while piracy is relatively well-contained in developed countries with effective legal systems, it’s a huge drag on potential growth in emerging markets. But the effects of piracy don’t need to be a drag on any technology- or media-centered portfolio if investors keep a focus on companies that can treat piracy as just another market force or competitor. Look to companies that can win by out-competing piracy, as Apple has done with its new line of Shuffles, or firms like IMAX that are profiting from innovations meant to stimulate new experiences that copycats can’t emulate.
So when you see Apple effectively fighting piracy with design, don’t act so surprised -- this is the company that is famous for literally flying the Jolly Roger at its headquarters. It's not surprising that it would find a polite way to make fellow pirates walk the plank.
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