Apple's Newest Strategy: Free

Apple's big event on Tuesday didn't have very many surprises. We got the expected updates to the iPad and Mac product lines; the new OS X update didn't have anything we didn't see at the developers conference in June. What was surprising was that Apple decided to give away OS X Mavericks for free and its next generation of iWork and iLife come free with the purchase of a new Mac.

Source: Apple's Keynote Presentation.

This is the power of Apple. Microsoft couldn't give Windows away. Not even Google gives away software like this. Apple's position as an integrated hardware/software company makes giving away its software potentially more profitable than selling it.

A loss leader
Giving things away for free or lower than cost appears to be a new trend at Apple. It previously sold upgrade licenses for OS X for $19.99, one-tenth the typical cost to upgrade Windows Pro. Apple's probably not making money on these upgrades considering it has less scale compared to Microsoft. Microsoft sold 100 million licenses for Windows 8 in its first six months compared to Apple selling just 28 million copies of its previous iteration of OS X, Mountain Lion, over the last year.

Earlier this year, Apple unveiled iTunes Radio. It almost certainly takes a loss on the service as music streaming is notoriously difficult to make a profit on. Just ask Pandora.

Now, it's giving away its best software. The idea is that providing its customers with the best possible experience for one simple price will help sell more hardware. The software is already priced into the hardware.

Everyone wants to be like Apple
Google has long championed the strategy of giving away its software in order to draw more people to its lucrative advertising business. The strategy has been rather successful for the company, but it's not nearly as powerful as Apple's strategy.

Apple controls the margins on its hardware products, whereas Google is susceptible to the market's demand for ads. While more eyeballs on Google ads is certainly great for the company, there's some market risk in the strategy that's absent in Apple's hardware strategy.

Moreover, neither Google nor Microsoft is as good as Apple when it comes to selling hardware. The two competitors are software businesses trying to push hardware. Most recently both companies are trying to sell phones and tablets with Google buying Motorola and Microsoft buying Nokia's devices segment.

Neither is doing particularly well selling hardware, but the overarching point is that they've practically conceded that the integrated software/hardware business is superior to a stand-alone software business.

In fact, Microsoft offers a similar package to Apple's most-recent software/hardware deal -- buy a new Surface 2 and get Office free. Office is a huge part of Microsoft's business, accounting for more than one-third of the company's revenue in Microsoft's fiscal fourth quarter ended June 30. It's one of the biggest draws of Windows PCs -- Windows tablets and phones are the only mobile devices for which the suite is available.

Whether the strategy pays off for Microsoft remains to be seen, but the fact that Apple now offers a similar deal with iWork and its industry leading iPad doesn't help its chances.

The power of premium
Apple sells its hardware products at a huge premium. Its gross margins are outrageously high for a hardware company. This is what makes it possible for it to give away its software. At a premium price, Apple is able to give its customers a premium experience with both hardware and software. This will make customers happy, and happy customers are loyal customers.

When will Apple destroy the iPad?
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Adam Levy owns shares of Apple. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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