By Cyrus Sanati, contributor
FORTUNE -- Potentially weak iPhone demand is just a symptom. The back and forth in recent days about a cheaper iPhone belies what may be a much larger problem for the world's dominant gadget maker: Apple seems to be repeating a mistake it made nearly two decades ago by making it difficult for developers and peripheral makers to work with the company. At the same time, Apple is maintaining a premium price for its products, hurting adoption in developing markets. A radical departure by chief executive Tim Cook is needed fast if Apple is going to stay on top.
All the big names in tech were at the Consumer Electronics Show in Las Vegas in some fashion—except, of course, for Apple (aapl). For the past two decades, it has eschewed the mega conference, participating in MacWorld instead. Now, Apple isn’t even showing up at MacWorld, preferring to unveil its new products on its own schedule. At the height of the iPhone craze a few years ago it was understandable that Apple could get away with maintaining such an aloof stance. The iPhone was truly a revolutionary product with massive margins. Apple’s iTunes music and entertainment portal was a cash cow, finally bringing the record companies to terms with the digital music space and giving consumers a simple and easy way to purchase digital media for the first time. And with the advent of "apps," Apple once again created an entire ecosystem.
Apple’s control of the iTunes and app store portals gave it total control over this new mobile world. It used that control to shape the market in its image, forcing developers and peripheral makers to jump and bend to the company’s every desire. If you wanted your application in Apple’s App Store or if you wanted your song on iTunes, you had to go through a long and laborious process with Apple HQ to make sure everything was up to their standards. Apple’s domination of the paid electronic mobile download space translated into mega profits, which last year culminated in the company posting a cash balance of around $100 billion. Apple was making so much money it literally had no idea what to do with it.
But it is naive to think that Apple could continue to dominate the growing market for smartphones. The company has seen its market share in the smartphone space fall from 23% at the start of last year to 14.6% by the third quarter. Apple’s stock took a major dive this week, falling at one point to an 11-month low, on reports that orders for its iPhone 5 display had been cut in half from previously planned levels, noting that sales have not been up to snuff. The reports came out of Asia where Apple’s iPhone is assembled. (Apple did not respond to request for comment for this story.)
To be sure, Apple isn’t going bankrupt and the iPhone 5 isn’t a dud—it sold a record 2 million copies in the first 24 hours it went on sale. But the iPhone’s recently lackluster track record, combined with this talk of weak demand, is of major concern to investors who have bet big on Apple in the last few years.
Even though the iPhone 5 sold well initially in the US, that doesn’t mean it will continue to sell well going forward, especially in developing markets. It continues to command a premium price in an increasingly crowded marketplace. (Last year, Apple introduce one new phone. Its arch-rival Samsung? Thirty-seven.) And yet, Apple continues to maintain its old methods. Take the way it runs its iPhone program: as if it is the only game in town.
At CES this year, there were a number of innovative products available for use with an iPhone—ranging from apps like PGI’s iMeet, a truly usable and clear video conferencing program, to peripherals like Lifeproof’s Fre, a truly slim and sleek shockproof and waterproof iPhone case.
But what was missing was an array of products that took advantage of the iPhone 5’s new lightning connector. Last year, Apple shocked everyone by summarily discarding its 30-pin adapter and moving to an 8-pin version called lightning. For years everyone from car makers to case designers had made some sort of peripheral that interfaced with the iPhone using its 30-pin adapter. But overnight, Apple changed the game, endangering millions of dollars of inventory and leaving companies scrambling to create new versions of their products. Apple charged consumers a king’s ransom for an adapter for use with their old peripheral devices.
Changing formats is nothing new in the technology world, but it is what Apple did after which is truly troubling. Instead of releasing the technology to its partners immediately, it limited access to the lightning adapter. Wonder why there aren’t many stereos or battery cases available for the iPhone 5? That’s because Apple hasn’t approved any – none, nearly 6 months after the release of the iPhone 5. A rep for Mophie, one of the largest makers of battery extenders, told Fortune that the process for iPhone testing was exhausting and frustrating but that the company was almost through what he called the Apple “gauntlet.” The Apple delay meant that Mophie missed out on the holiday season, a major frustration.
The Apple gauntlet isn’t just a feature of the hardware space; it is also a factor in the app space. It took app makers the AppStreet Boys a full year to get the ok from Apple to release their popular game, Guess Dat Song. The game, which is essentially the digital version of the famous 1950′s game show, “Name That Tune," used the music in Apple’s iTunes store as its content source. Apple was extremely reticent to allow an app access to its iTunes catalogue and kept the AppStreet boys jumping through hoops for months, eventually giving them the green light.
The Appstreet boys are certainly not alone. A number of app developers at CES expressed major frustration with Apple’s so-called “testing” apparatus. Apple was accused of constantly “moving the goal post,” and being cryptic as to what was and what was not acceptable for entry into its iOS app catalogue. Months of silence from Cupertino were followed by bizarre requests ranging from small tweaks to complete redesigns. The extra time and money associated with the iOS gauntlet had some app developers decide to bypass Apple all together and design their app for the rival Google operating system, Android, first. Unified Remote, an app that allows users to control their PCs using their phones, was first launched on Android and has yet to be launched on iOS.
Apple has defined itself by keeping its operating system close to its chest, forcing app developers and program makers to bend to its wishes. It has also refused to allow other phone makers to use its iOS, meaning that only Apple products can access iTunes and the iOS app store. That was fine when Apple dominated the smartphone market but it’s downright foolish now. Google’s (goog) Android operating system, while not as elegant as Apple’s iOS, has come a long way and has permeated pretty much the entire smartphone market. Nokia (nok) abandoned its OS, Palm is gone, and Research in Motion (rimm) and Microsoft (msft) continue to struggle.
Apple would be wise to look back two decades when it was locked in a war to control the personal computer market with IBM. Like today, Apple kept its computer architecture and OS close to its chest, refusing to share it with other manufacturers while at the same time making program developers jump through a lot of hoops to get Apple certified.
Meanwhile, IBM built its PC using an open architecture with off-the-shelf parts using Microsoft’s Windows OS to drive its machine. Eventually, all the other computer hardware manufacturers consolidated behind the PC architecture and started using Microsoft’s Windows platform as well. While those first IBM clones running Windows weren’t as elegant as Apple’s closed system; they were cheaper and easier for programmers to manipulate. Eventually PCs became as good as or arguably better than anything out of Cupertino. The number of PCs in operation by the end of the 1980s vastly outnumbered Apple computers.
If it weren’t for the iPhone, Apple today would be a niche computer maker. The iPhone has turned Apple into a distributer of content, making it richer than anyone ever imagined. But its rigid adherence to its arbitrary rules and its secretive and closed culture is beginning to threaten Apple’s profits. While the iPhone remains an amazing piece of machinery, there are now a host of other smartphone options available to consumers across various price points – most, if not all, of them running Google’s Android operating system.
There are a number of things Apple could do today to ensure it doesn’t relive its 1980s meltdown. It could for one open up its iOS so that other manufacturers could integrate it with their phone. This will bring a new line of customers into the iTunes orbit. It could also create a larger line of phones to fit a multitude of price points. After all, the iPhone is simply a delivery device for content—the more people you have on your network, the larger your revenue. If Apple continues on its current path, it could lose—a lot.