Apple, Tech Firm or Not?
Yesterday’s post on Apple’s recent correction and current rally was, for the most part a technicals driven analysis with attention paid to short term catalysts. I thought I’d sound off a little on my impression of Apple as a longterm story. The focus here is more on Apple’s strategic position than on crunching its fundamental value or making an attempt to assign a discrete value to its stock.
Apple’s Business
As the above revenue breakdown shows, Apple is still predominantly a purveyor of personal computers. More than 50% of its revenues come from the Mac suite of desktops and portables despite the fact that one would likely credit the iPod and the upcoming iPhone for putting Apple in its current position as one of the most recognized consumer tech products firms in the world.
Apple’s Competitive Advantage
Apple’s strategic position for all of its products remains that of niche, premium status. The company, to some degree, manages to keep pricing power over its products through product differentiation and by maintaining a line of products which is nearly always employing some type of high-end technology – flash based hard drives, multi-touch screens, etc. As a result, the company has managed to keep its products from being commoditized much like those products of other computer manufacturers like Dell and HP or other types of MP3 players like those manufactured by iRiver or Creative.
As a result of this distinction, Apple is a very different kind of tech company, if you can describe it as a true tech company at all. While Apple benefits from the general ebb and flow of PC growth, proliferation of new technologies, and improving communications infrastructure, it’s main competitive advantage and the moving force behind its success has been closer to that of a retailer. By building out Apple stores and creating a brand presence, it’s created its own Apple-culture. This base of consumers is a regular source of repeat revenue and watches for Apple’s seasonal roll outs of updated designs (and sometimes new products) much in the same way fashionistas follow their favorite clothing designers.
The success or failure of Apple’s growth strategy is equally dependent on technology aspects of the company’s products as it is on its ability to hit consumer trends and keep its base happy. Apple may well be the first true hybrid consumer retailer and technology company.
Apple’s Growth
Thus far, it seems that Apple’s growth has been driven by the success of distinct product classes. First, the iPod. Next, the iPhone. As its computer market share could be described as minority at best, these products have had to be open to other third party systems and as a result have not been able to deliver to Apple the kind of integrated strength it likely had hoped for. This is why I describe the firm more as a retailer – you buy distinct Apple products – rather than a tech firm – you need Apple’s products and systems and you need them as a unit.
Apple’s renaissance as a high tech retailer was borne out of necessity more than plan. Given the company’s rigid protection of its products from third party developers, it’s not hard to imagine that had Apple had the benefit of a Microsoft-like stranglehold on the world’s computing market, it would likely have taken advantage and created an even more closed off suite of hardware and software than it has already. iPod sales would have directly translated into Mac sales which would have translated into software sales. They probably could have developed an iPhone which syncs more nicely with your home computing solution rather than one which, for all intents and purposes, operates outside of the desktop environment. This is the kind of tech-like growth that one likely expects from Apple, but won’t happen until its core computing business reaches critical mass.
The good news is that the long predicted “halo-effect” of iPod and iPhone sales leading to Mac sales is starting to pay dividends. Mac sales are finally taking off and Mac is slowly but surely eating away at computer marketshare in the US. Most recent estimates show that Macs are capturing 7.5% marketshare compared to barely 6% marketshare a year ago. This is just in time as its iPod product class is reaching saturation and the Mac product class gives them the strongest foundation on which to build further success.
Looking Forward
Where are the growth drivers now? With iPhone growth tapering off, Apple must now count on the growth of iPhone and Mac sales. Given the current P/E ratio the stock has, the company needs to continue growing at 25-30% a year to justify its valuation. Assuming that margins will remain steady, they need to generate 5-8% revenue growth every quarter to do this. With the iPod and iTunes have already captured monopolistic market share, outsized growth from these revenue streams cannot be counted on for much longer. The iPhone too can likely not be counted on for growth past that of the iPod as even the best mobile phone apexed at 60 million annual unit sales and that was the RAZR, a far cheaper and more down market product.
To achieve the kind of growth everyone is expecting a long term basis, Apple will have to do more than simply be a hit maker – lest it go the way of Steve Madden or the Gap. It must, instead, begin focusing on bring their products together and truly capitalizing on the “iLife” idea. The US PC market is reaching maturity as almost everyone in the world needs one. Luckily, Apple is in a position to take market share and does not have to depend on industry growth to succeed. Research shows that most iPhone users carry more than one phone. Implying that either Apple has not found a sweet spot in the mobile phone market and I believe it may be better off attacking the nascent ultramobile PC market. A range of at-home and on-the-go technology solutions all driven by Apple OS solutions is the key to its success in the longterm as it will give the Apple brand a significant moat around its business beyond that of a zealot consumer base and a well-recognized brand. It’s products will transcend the traditional retail cycle and become necessity in the same way the best true tech products have – Google Search, online shopping, and, yes, Microsoft Windows.
For now, it is up to Apple to seize on its consumer driven success and drive its consumer base towards its computing products and continue to expand Apple’s influence in their everyday day lives.
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