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The iTunes Profit Myth

In an article for entitled “The Microsofting of Apple?,” editorial board member Holman W. Jenkins Jr., writing an opinion piece for the Wall Street Journal, makes the silly mistake of comparing Microsoft’s predatory methods to compete with its rivals with Apple’s ascendancy in recent years. As with many of Apple’s staunchest critics, Jenkins’ lack of understanding of Apple’s financials and business plans are troubling. Worse, in this case we’re talking about the editorial pages of U.S.’s largest daily newspaper, and a Wall Street icon.

Consider the closing sentence: “An Apple that rolls out increasingly junky devices merely to lock more and more customers into the iTunes-App Store mall is one gloomy possibility.”

Let’s forget for the moment the characterization of Apple’s iPad and other recent products as “increasingly junky devices.” I see no evidence that Jenkins has more than a cursory level of knowledge about the iPad. He doesn’t say whether he attended Apple’s press event rolling out their tablet-based computer last month, or has otherwise had an opportunity to even touch one. Besides, he seems to be more concerned about Apple’s decision not to support Flash, since he feels that approach will deliver a subpar Web experience.

Flash, to Jenkins, is a good thing because it is “installed on 95% of PCs.” He repeats the “McDonalds argument” often voiced in favor of Microsoft ownership of the operating systems market by equating ubiquity with quality. He also wants us to believe that the efforts of Steve Jobs to move us from Adobe’s proprietary standard to the open multimedia standards being considered for HTML5 is somehow wrong. That, my friends, is the polar opposite of what Microsoft has traditionally tried to do, which is to lock people into their own standards not just to enforce their dominant position, but to make lots and lots of money from licensing fees.

Jenkins seems ignorant of the fact that Apple actually earns, at best, modest profits from iTunes and its various online divisions, including the App Store. The piece of the action Apple takes to run the system and process payments largely covers the cost of doing business.

How do I know that? Well, according to Apple COO Peter Oppenheimer, iTunes and the App Store, as of the last financial quarter, were “running a bit over break even and that hasn’t changed.” Sure, I suppose Jenkins can counter that statement by claiming Apple is lying, but that sort of behavior would violate a host of SEC laws. If they were caught fudging the books, they’d face fines and possible criminal penalties, not to mention a severe loss of confidence from the financial community.

The reason there is an iTunes and an App Store is to sell Apple’s hardware, from which they derive the lion’s share of their profits. Besides, whether you purchase product from iTunes is up to you, and nobody forces you to buy a single thing. In fact, if you choose to download something from the App Store, you can restrict yourself to the free stuff. When it comes to the iPod, you can transfer MP3 files to iTunes that you’ve acquired elsewhere (legal and otherwise), or just rip your own CD collection.

Why doesn’t Jenkins realize this? I don’t pretend to have an answer, except to suggest he’s been locked up in his ivory editorial tower for so long that he hasn’t come down to do any real world research.

The problem is that far too many of Apple’s staunchest critics view the company as an amalgam of Microsoft. If Apple gains a huge share of a market, such as digital music, that’s a bad thing. How could it be otherwise, since Microsoft pulled nasty stunts to own the operating system and office suite markets? Big equals bad.

One key reason why any of this is coming up is because Apple may surpass Microsoft in market cap this year. For those of you whose eyes glaze over from such buzzwords of the financial world, Wikipedia states that “Market capitalization/capitalization (often market cap) is a measurement of the size of a business enterprise (corporation) equal to the share price times the number of shares outstanding of a public company.”

In a sense it’s an artificial figure. If the stock market trends downward, a company is worth less, even though sales and profits may remain unchanged, and, in fact, are exceedingly high.

Now to be fair to Jenkins and others who have voiced similar wrongheaded ideas, it is fair to criticize Apple about the lack of Flash support. Certainly customers are being inconvenienced, and the iPhone and now the iPad will definitely not offer a full Web experience until this shortcoming is somehow remedied. It’s not as if Flash will go away tomorrow, or the next year. Far too many Mac and PC users have Flash, and it would require lots of work for Web developers to remove such content and seek other solutions.

Even then, what other solution would they choose? Sure, there is a growing level of HTML5 support in non-Microsoft browsers, but two thirds still use Internet Explorer, and for that app you’ll still need Flash.

One can always hope Apple and Adobe will kiss and make up and deliver a Flash solution for the iPhone OS. Despite all the posturing from Steve Jobs at public and private meetings, that would still be the most reasonable solution.

But lack of support for Flash won’t turn Apple into another Microsoft. When he makes claims of that sort, Jenkins simply demonstrates that he is nothing more than another clueless pundit.