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Think Diffident

Tuesday, January 23, 2007

Sarbanes-Oxley has helped make Apple and other innovators timid.

At an Apple Store a few weeks ago a clerk had to take down info from my driver's license so that I could qualify for an education discount that previously only required that I flash my faculty ID. “Sorry, Sarbanes-Oxley,” she said. Really? “Yeah. Also, if you buy a custom Mac now, you have to have it shipped to your home; you can't pick it up at the store anymore.” Well, I’ll be, I thought.

It was therefore no surprise to me when Apple last week announced it would charge a completely nominal $1.99 fee to unlock a hidden feature in recently shipped computers. Critics say Apple simply blames accounting regulations for its unpopular policies. Are they right? Or does Apple really have its hands tied?

If toughened accounting rules inhibit innovation and entrepreneurship, they may be a good that is the enemy of the best.

Apple plans to charge many of its laptops’ owners for a feature that is already built-in to the machines. Wi-Fi, the technology that allows computers to wirelessly connect to the Internet, comes in three flavors: b, g, and n. Each communications standard is respectively faster and has a longer range. The “n” standard has not yet been ratified by the Institute of Electrical and Electronics Engineers, but will be soon. Always on the cutting edge, Apple included n-capable Wi-Fi cards on its recently shipped computers. Not wanting to commit to the technology before it was ratified, Apple only described the computers in packaging and marketing as g-capable. 

Finding out that their computers had faster Wi-Fi cards already in them was a pleasant surprise for Apple’s customers—something like buying a 14-carat gold ring and later receiving a letter from the jeweler, with his compliments, saying the gold is actually 18-carat. With a quick software update from Apple, customers’ “g” machines would become “n.” Voila, a surprise instant upgrade that means happy customers and good karma for Apple (which is probably an important thing for its noted Zen Buddhist CEO Steve Jobs).

According to Apple, however, accounting rules have complicated matters.

Apple was between a rock and a hard place. On the one hand, if it had announced that its computers were shipping with n-capable cards that would be activated later, it would have had to wait to record some of the revenue garnered from each computer until it actually activated the feature. That would have been an accounting nightmare. On the other hand, not having acknowledged the feature when the machines first shipped, Apple can only count it as a valuable feature if it charges users for activation. That way, the original product was “complete,” and accounting rules let Apple count all of the revenue when the machines were sold—the intuitive, straightforward accounting approach that a reasonable observer would expect.

Instead of good karma, Apple’s announced “nominal distribution fee” has brought it scorn. A large contingent of bloggers and other pundits on the web are claiming that Apple simply blames Sarbanes-Oxley whenever it does something to inconvenience customers.

The rule that made Apple’s mess predates Sarbanes-Oxley—but Sarbox’s stiffened penalties may well have changed Apple’s calculus. What was previously an accounting principle that could have, in a special circumstance like this one, been benignly neglected with the use of an explanatory footnote, the Act now makes rigid. The possible criminal penalties that can now attach to any unusual accounting mitigate the incentives to account for things elegantly, when the elegant way of keeping track of things requires some added explanation.

Apple I Computer by Flickr user EuthmanConsidering the blowback following its announced charge, one might wonder why Apple would ever again go through the trouble of unlocking hidden features for its customers. How many other features have Apple and others held back simply to avoid accounting headaches? An update to some iPods models last year that Apple refused to give to other models technically capable of receiving the upgrade comes to mind.

If toughened accounting rules inhibit innovation and entrepreneurship, they may be a good that is the enemy of the best. Earlier this month, venture capitalist and Netscape founder Jim Clark quit as chairman of the board of photo-sharing web company Shutterfly. In his resignation letter, he cited “my having any significant role on the board.”

“Sarbox dictates that I not Chair any committee due to the size of my holdings, not be on the compensation committee because of the loan I once made to the company, not be on the governance committee, and it even dictates that some other board member must carry out the perfunctory duties of the Chairman.” He continued, “What’s left is liability and constraints on stock transactions, neither of which excite me.”

All regulation—good and bad—results in unintended consequences. Now that the consequences of stringent accounting laws are becoming clear, maybe it’s time to give them an upgrade.


Image credit: "Apple I Computer" by Flickr user Euthman

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