Tuesday, January 16, 2007

Buy Base Station to Get Software Update

Core 2 Duo–based Macs ship with 802.11n-capable hardware, but to get the software to enable this you have to buy a new AirPort Extreme base station. According to iLounge, this is not because Apple’s trying to push base stations, but rather because they’re trying to comply with accounting rules from 2002’s Sarbanes-Oxley Act:

The company believes that if it sells a product, then later adds a feature to that product, it can be held liable for improper accounting if it recognizes revenue from the product at the time of sale, given that it hasn’t finished delivering the product at that point.

In other words, it may be illegal for a public, US-based company to issue a free software update that adds features. I’m not a lawyer, and I haven’t read the Act, so I have no comment on whether this legal interpretation is correct.

31 Comments

I wish I could be more specific, but a friend of mine who worked at a company that rhymes with ... um ... "Fanobe" ran into this problem. There was a feature they were working on for a major product, but it had to be cut out because of time constraints. "Aha!" he thought- we'll just ship it as a free plugin after the main product has been released.

No go- Sarbanes-Oxley screwed that whole idea up for the very reasons you write above :)

I've heard rumblings about this exact problem for *years*—that they have to run new features in software updates by Legal to make sure they don't run afoul of this. So it's not something invented for the 802.11n drivers, though it might be the first time they actually said "no" and the results have been felt.

I've been hearing about this problem from a, uh, rhymes-with-Kenobi developer too.

It seems ridiculous, but perhaps the intent is to keep companies from charging for "vapor" features, promised but never delivered?

No, the reason they do this is to prevent companies from reporting "sales" on their books that have not yet (substantially) happened yet. This makes the quaterly financial report look good. This kind of accounting frog was the root of the Computer Associates criminal prosecutions, among others. The problem is, they don't/can't make a distinction between almost-vaporware and and minor updates.

"Fraud" not frog. See what trouble I get into when there is no preview button?

WordPress seems to have that problem a lot, Dan.

What about this feature makes it problematic legally? Haven't there been a number of updates to applications like Safari which were significant?

I was starting to think it had to do with hardware vs software, but if this hypothetical Adoromedia wanted to ship a software update later, that sort of kills my theory.

No, it's all about recognizing revenue.

If I'm going to sell you a car, and one of the "features" of the car is the engine, I can take your money at any point. However, I can't record the revenue in my books from the car until I've finished delivering the car to you.

This is to prevent companies from recognizing the sales of thousands of cars to make a quarter look good, even though they're not going to be delivering the full product for months or possibly years.

A more realistic example: Let's say you order fiber to your house, and I agree to provide it. You pay me, but it doesn't actually count as revenue until I've installed it.

Might this also explain the non-appearance of iLife and iWork at Macworld? If they both have some features that would only work with Leopard, then Apple would have the same problems if they released the iApps first...they wouldn't be able to just enable the Leopard-specific features later. So they have to wait until Leopard itself is released.

Would this practice be related to why companies use mail-in rebates to artificially claim revenue for certain quarters? Or is it purely out of faith that a significant portion of customers never send them in?

I have now heard from a few different people about very specific situations in which their vendors or the firm they work for had to do precisely what Apple is going to do.

Of course, Apple is not going to try to prevent people from exchanging the enabler. And I would suspect it can be bundled with Leopard since that's a full-price item separate from the computer's original sale.

> "If I'm going to sell you a car, and one of the "features" of the car is the engine, I can take your money at any point. However, I can't record the revenue in my books from the car until I've finished delivering the car to you."

I can't really see what the problem is if the product (e.g. my MacBook Pro) wasn't advertised as 802.11n at the time. Apple sold me a laptop was, as far as I knew, only did 802.11b and g. They delivered that, completely, when I bought it.

All the want to do now is make that product even better, for free. Well, thank goodness a) there's an American law that stops them from doing that, and b) I live in the UK.

I think you guys need a ruling on this. I can't see any judge worth their salt suggesting this is improper accounting.

I agree with PaulDWaite above ... if I was sold something as Product A and I knew it was just Product A. How does it make it any different if Product A still performs as originally advertised and purchased after a software update?

The car example above doesn't relate well. I would say it's like I buy a car with a digital radio. I don't have digital radio stations in my area, but when digital radio starts transmitting in my area am I charged for the extra features (like song title and radio station name)? The answer: No.

I think this is just a situation where Apple is being very publicly "GREAT ACCOUNTING WORK" because of the SEC probe.

Unfortunately, there are few judges that would be willing to go toe to toe with the albatross that is SarbOx. SarbOx compliance is the #1 reason NOT to go public today.

The key here is that under sarbox, releasing an enabler for functionality that was not ready when the revenue was booked for the machine would require the revenue for each machine they enabled to be rebooked. The issue is one that is facing EVERY software and hardware vendor that falls under SarbOx. This is one of the primary reasons I wanted to get out of my Fortune 1k, publicly traded company. SarbOx was making the practice of writing software so painful that it wasn't fun.

Apple is just one of the first to make the tough call to have to do it this way. It sucks to be them, but more importantly, SarbOx sucks, and was a typical knee jerk reaction to Enron by congress. It was poorly thought out legislation that is intended to prevent Enron type scandals, but in reality costs the consumer far more than any Enron type scandal ever did.

What about the new macbooks and stuff? They could come with the enabler... That would be a good idea.

> It was poorly thought out legislation that is intended to prevent Enron type scandals, but in reality costs the consumer far more than any Enron type scandal ever did.

To be fair, it was never really about what Enron cost consumers.

It's a matter of the damage do to investors, employees and the general public trust.

err... "damage done to..."

As I understand it, it's not the software that's the issue, but the hardware.

From wifinetnews:

"In several reports, the law is cited as requiring different accounting for earnings on products that are shipped and later provide new functionality that wasn’t initially advertised. Charging for the updater means that the functionality didn’t come for free."

SOX compliance is a massive bugaboo for my organization, and we aren't even publicly traded (but we do information management for some companies that are).

SOX was indeed poorly thought-out "knee-jerk" legislation, drafted and quickled approved/signed to give the appearance of "doing something". The cost of SOX compliance is already costing US companies millions of dollars, and the implications for corporate IT in terms of records and data retention are staggering.

Important: It's not US-based companies, it's companies that are *listed* on US Stock exchanges that are hit. Where-ever they're based.

Best way around it seems to be to not be listed in the US.

Also, won't TiVO get into trouble? (or does the subscription fee take care of it?)

I didn't put together the SOX connection until just now, but we had this problem at one of my previous jobs. We had promoted a feature as a key part of either a 4.5 or 5.0 product release (I don't remember exactly).

It became clear that the feature wouldn't be done in time for the product release, but we still needed to release the product because other features were required for interoperability with our other products. So, we released the product sans promised feature and refrained from recognizing the revenue until we released the last figure via a free upgrade.

I worked for a place that got bit by this: we had announced a major software/firmware update for one of our hardware products that would be free to our existing customers. The schedule slipped into the following quarter, and we ended up unable to report any revenue from the sales of the product that took place after the announcement was made.

As it was explained to me at the time, we were now selling a product based on the yet-to-ship features, not on the currently-shipping features, and that caused SarbOx issues. My understanding was that it was our announcement of the new features that created the issue (i.e. had we not announced it, like Apple appears not to have, it wouldn't have been a problem) although I'm not certain that was really the case.

Indeed, it seems odd that SOx would come into play when Apple in no way sold the products declaring that they had even the potential for 802.11N.

And what of Mac Pros? They have 802.11N chips in them, right? But they have Xeons, not Core 2s, of course.

Derrr, I was being lazy. Sorry. Yeah, I too have an 802.11N card, but nobody mentions the Mac Pro when talking about this issue.

From http://www.apple.com/wireless/80211/:
iMac with Intel Core 2 Duo (except 17-inch, 1.83GHz iMac)
MacBook with Intel Core 2 Duo
MacBook Pro with Intel Core 2 Duo
Mac Pro with AirPort Extreme card option

Guys, it's not Sarbanes Oxley, it's GAAP. SOX is commonly blamed for stuff like this, even though it is not the case.

Sarbanes is about processes and controls. The US's GAAP outline the approaches on revenue recognition.

Apple is taking an unusually strict but correct intepretation (according to my accountant wife) of the rules with respect to the draft-N enablement, but it's probably related to the fact that Apple is also embroiled in an Options backdating scandal.

Avoiding the SOX arguments, I thought I'd mention your post as written isn't currently true. Apple has indicated that the new software will ship with the Base Stations, it has been agreed upon (though not verified) that the software will also be apart of Leopard; and of course the widespread rumors of being able to purchase the update/upgrade for $5 on CD.

So it seems that Apple won't give you the updater for free; but you can get it buy purchasing a number of different items, purchasing the CD, or I bet once the installer is available—downloading it through a number of different websites.

allgood2: Leopard probably will include the updater, but Apple hasn't confirmed this, and Leopard doesn't even have an announced ship date. The $5 CD is so far just a rumor. So I think my post is correct that right now the only announced way to get the update is to buy the base station.

That’s crazy! It sounds like it’s just an add-on or extra feature. The sale without it is complete and stands on its own, therefore they can recognize revenue when the sell the Mac. They would just recognize additional revenue when they sell the additional base station. They are two stand alone sales that each recognizes revenue separately. The criteria to recognize revenue is:
Evidence of an arrangement (order, contract, etc.)
Fixed or determinable price
Title (or ownership) has transferred
Collection is probable
Obligation to pay is not contingent on another act
Future returns can be reasonable estimated

He’s probably referring to the obligation to pay be contingent on the sale of the base station, but I doubt that’s the case.

Hmmm... the other way to look at it, which would be compliant, yet free, is that the new features are ***not*** a feature of the previous sale, but are a feature of the new enabler (and that it's just another free software package like iTunes). Thus the previous sale is complete, and can be recognized at the time.

Glenn Fleishman gets confirmation from Apple that you’ll be able to get the update for $1.99 (via John Gruber).

But wait, what about the iPods? I've owned both 1G and 3G iPods, and both saw significant updates via firmware for several years. Things like podcast support and whatnot (it's been so long, I can't remember any more specifics - and can't find the appropriate kbase articles).

Another example: Microsoft has added many new features to Windows XP over the years, including a full-blown firewall. Heck, Service Pack 2 was almost completely new features. How come that doesn't count either?

Am I missing something?

Mike, your skepticism is shared by accountants who, according to the WSJ, are calling bullsh*t on Apple's claim.

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