Best drummer in the world? He's not even the best drummer in The Beatles!
--John Lennon, ca. 1964.
Any musician can tell you how critical a great drummer is to a band. This week, Apple (AAPL 0.93%) introduced another example of how innovative the company still is, with its latest feature in Garage Band: Drummer. And while Drummer itself isn't a new feature -- it's been in Logic Pro for a while -- Logic Pro is a powerful $199 software suite, while Garage Band is free for OS X users. Apple's latest version of OS X, Mavericks, iLife, and iWork are also now free for Mac users. And that's the innovation.
While it may sound counterintuitive to call "free" an innovation, a look at the larger picture shows something different.
Loyalty to the ecosystem
When Apple announced at this week's event that it would now give away its desktop operating system, OS X Mavericks, this was further indication that Apple is willing to move beyond its legacy -- even at the cost of disrupting its own business for a time -- and innovate. And right now, that means keeping users in its ecosystem, even at the cost of the lost revenue from OS X sales.
This transition has been coming for a while, as the cost of OS X upgrades and full versions has fallen with every recent release. Toss in the changed model in mobile, with the operating system (and subsequent updates) being included as part and parcel of the product itself. This is true not just for Apple iOS, but also for the various versions of Google's (GOOG 0.59%) Android, which it gives up for free to smartphone and tablet manufacturers. And Apple is making a serious effort to extend this shifting dynamic to the world of the desktop, and keep as many desktop users plugged into their Macs as possible.
Simply put, if someone can squeeze another year out of their old Mac via a new version of OS X, especially if their primary devices are an iPhone or iPad, this strategy pays off for Apple in a big way. Add in the fact that while Macs don't really cost much more than similarly configured PCs, they are more expensive than many budget-minded Windows-based machines. But when you start factoring in the cost of new versions of desktop software, and upgrading the operating system, all of a sudden those expensive Macs -- over the life of the product -- aren't so expensive. Google has taken a similar tack, with its free web-based Google Docs software suite that has freed many casual users from the expensive shackles of Microsoft (MSFT +1.80%) Office.
The key for Google and Apple is that they don't need to make money on the software. These applications are just part of a larger picture. For Google, the driving factor is of course, search and advertising. Every way that Google can draw users into its sphere -- whether search, Google Docs, YouTube, or even self-driving cars in the future -- is just another chance to put advertising content in front of eyeballs. And with annual revenues growing at a 20% clip for most of the past decade, it looks to be a bargain that users are happy with.
Apple is focused on making amazing devices, which means the software is simply a part of the whole. And Apple has drawn a line in the sand on what it thinks should be part of the product, and what should cost extra. Simply put, Apple doesn't think you should pay up -- down the road -- to have the best possible experience with your Apple product.
Stuck in the old way
Even as it transitions to a "devices and services company," Microsoft will be counting on software sales for a long time to come.
Last fiscal year, the Windows division generated $19.2 billion in revenue. Per the company's 10-K, 65% was from OEM sales, which means 35%, or $6.7 billion in revenue, was commercial and retail sales of Windows. That's about 8% of the company's sales last year; more importantly that 8% of sales is worth about 12.4% of Microsoft's operating income, our roughly $3.3 billion.
But as important as Windows is to Microsoft, Office is even more vital, with $21.5 billion in sales (29% of total revenue) tied directly to Microsoft Office. While iWork and Google Docs have mostly drawn the casual user who may not need the power of Excel but still need a spreadsheet app, Google Apps for Business is changing the game. At $5/month per user, (Microsoft charges about $150/year per user) Google Apps offers plenty of horsepower for the majority of users at a significant discount versus Office.
Final thoughts
While it's questionable to call Apple's Drummer feature better than Ringo Starr, it's no stretch to see that Apple and even Google are steadily pushing and changing the computer business to better reflect consumer sentiment, and not what the industry -- namely Microsoft -- might want. At some point, unless Microsoft begins turning the page quickly, its legacy dominance in the enterprise will begin weakening as companies shift to less costly, even free applications. And that makes both Apple and Google, which are marching to the beat of a different drummer, better choices for investors today.
