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Apple: Why Free Software Makes Perfect Mathematical Sense

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Apple is sacrificing a tiny bit of profit for a whole lot of competitive advantage.

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During Tuesday's iPad-centric event, Apple (NASDAQ:AAPL) dropped a historic bomb on the technology industry, and it's got nothing to do with Retina displays or motion co-processors or fingerprint-resistant oleophobic coating.

No, Apple's big news was that it was cutting the price of a good deal of its software to zero.

Going forward, operating system updates, including the upcoming OS X Mavericks from Apple, will be completely free, as will the company's iLife and iWork suites.

As you'll learn, Apple is giving away a tiny bit of dough for a whole lot of strategic advantage going forward -- if you can think long-term.

Apple's Tiny, Meaningless Sacrifice

Let's take a look at Apple's revenue breakdown from the June quarter:



As you can see, the iTunes/Software/Services segment accounted for 11.3% of revenues.

But let's look at what's in that category. Apple notes that it includes the following: revenue from sales on the iTunes Store, the App Store, the Mac App Store, and the iBookstore, and revenue from sales of AppleCare, licensing, and other services.

And in fact, in its most recent 10-Q, Apple noted that for the first three quarters of the 2013 fiscal year, 58% of segment revenues came from iTunes. That leaves 42% of the segment (or 4.7% of total revenues) to divide between AppleCare, licensing, and software, including OS X, Final Cut, iWork, iLife, and Aperture.

So what is Apple giving up here?

Not much -- maybe 2% of revenues at the most.

And What Is It Gaining?

Apple issuing free software is about one thing and one thing only: winning a long-term platform war against the Microsoft (NASDAQ:MSFT) Windows and Google (NASDAQ:GOOG) Android/Chrome ecosystems.

Back in 2010, I discussed why supposed iPhone killers should focus on targeting iTunes, which served as the glue of the Apple world:

iTunes has evolved from a piece of music-management software into something that 1) manages all your media, contacts, and appointments and 2) activates, syncs, and backs up the iPhone/iPad.

In other words, iTunes is now the personal operating system for millions of people, giving them a good reason to stay within the Apple ecosystem. When you buy a new Apple gadget, you plug it into your computer, and voila -- iTunes updates everything and you're ready to go, no thinking or effort required.

It's the most comprehensive piece of plug-and-play software on the market, blowing away the likes of Microsoft's Zune ecosystem and BlackBerry (NASDAQ:BBRY) Desktop software.

So the theme here is simple -- iTunes is the glue holding Apple together, and the piece of the puzzle competitors need to focus on if they want to hurt Apple.

No Apple product is an island, because each one cleanly ties together as part of an overall strategy -- get the people inside the house, and slam the door behind 'em.

Apple clearly emphasized inter-device software compatibility at the iPad event.

For example, you can start producing a song in GarageBand on the iPhone, then seamlessly finish it up on a Mac or iPad.

Now let's talk about consistency across platforms. Microsoft is running tablets with two different operating systems, and there are even more versions of Android in the wild.

Meanwhile, as it stands now, two-thirds of eligible Apple mobile devices are running iOS 7.

Why?

Because Apple exercises total control over its hardware and software, and iOS 7 is free.

And making OS X updates free means the same will be true for Mac users.
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Position in AAPL,BBRY
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