A New Way to Think About Apple’s Hardware Business

I have been thinking quite a bit about Apple’s hardware business. As many readers know, I believe Apple is equally a hardware and software company. I also believe they will naturally evolve into a services company wherein they will become equally a hardware, software, and services company in the future. All three of these segments will play a unique role in differentiating their ecosystem and deeply integrating their assets to form a consistent whole. I do not believe any other company on the planet can do what Apple can do to benefit from such an integrated strategy. This is what sets them apart and is why I am in the camp of those who take a long view of Apple. That being said, most people, when they analyze Apple, have them tipping the hardware side of the scale more than they should. This is why I propose a new way of thinking about Apple’s hardware strategy. Let me start by laying some foundation.

When we think about Apple’s core hardware products today, we observe their primary business is making computers small, medium, and large. ((Thanks to Jean-Louis Gassee for giving me this core observation)) The computers that fit in your pocket, your hands, and your lap/desk are the center of their hardware strategy. These will always be the products Apple can use to maintain their margins and continue relatively steady ASPs. This is because these hardware products are personal computers. The intimate nature of personal computing devices by default will keep them from becoming commodities in most cases. In particular, Apple’s small, medium, and large computers will never be commodity products because they run a computing operating system unique to their hardware. This is where the equal parts hardware/software company come into play. Because of this differentiation, these are the products Apple can sell at higher prices. These are the products where independent value will lie. These three products also cover the spectrum of Total Addressable Markets. The iPhone has the single largest possible TAM, followed by the iPad, then the Mac. But the key foundation we need to lay with regard to Apple’s hardware strategy is the volume and price combination.

Selling a higher priced product, that can also sell in high volumes, is the ideal revenue growth driver. Right now this product is the iPhone, which sells in higher volume than any other single smartphone on the market and at a higher ASP. For this reason, the iPhone is more than half of Apple’s revenue and will be for the foreseeable future. As they offer lower priced options, they need to sell dramatically more to maintain a steady line. For example, a company like Nokia can sell magnitudes more phones than Apple but not make nearly as much money. As the price of a particular piece of hardware goes down, regardless of margins, significant volume is necessary for it to make a blip on the revenue radar. This is the key reason why any new hardware from Apple that is not a core computing product and can’t sell at premium costs and/or in large numbers needs to be viewed more as a software and services story than a hardware story. This applies to both new “categories” being spoken about today such as wearables/smartwatches and TV.

I want to restate it is my conviction computing products are the ones Apple can sell at high ASPs, margins, and in significant volume. This is why it is hard for me to believe the hardware element alone for any wearable, smartwatch, or TV is the upside for Apple. Even if they sell a large piece of glass for $1500 or more, they will not sell it in large volumes even though the ASP could be high. The same is true with a wearable or smartwatch. Even though volumes could be higher, the ASP will not be. Meaning volume is key for the revenue on the hardware to be significant. How many $199 wearables would they need to sell for it to register on the revenue radar? If they keep their traditional margin strategy, the cost would be quite higher than $199. Knowing the build of material costs of these devices — the screen, the sensors, etc. — if Apple does keep margins on one of these products it would be quite costly. As the cost goes up, the TAM goes down. This is why I propose the new way to view Apple’s hardware strategy — outside of computers small, medium, and large — is to not view the iPhone, iPad or Mac at the center but to view iOS at the center.

Putting that statement a little more clearly, a TV, smartwatch, health and fitness wearable, car, etc., are all accessories to iOS. The hardware itself is simply a feature of iOS. This strategy deepens the ecosystem and lock-in for Apple but also highlights the benefit of the software and services upside. For example, a health and fitness wearble could tie deeply into iOS and open the door to subscription services, payments or authentication for example. For other companies looking to compete in the health and fitness wearable space, Apple can uniquely offer them tie ins to iOS that ensure their iOS accessory works best with iOS. As these companies build in services like subscriptions or coaching or nutrition advising for example, Apple can sit in the middle of those as well. Accessory hardware simply becomes a feature of the iOS ecosystem. Given the centrality of the iPhone, one could even state it by saying accessory hardware becomes a feature of the iPhone.

If we view lower cost hardware as a feature of iOS, it serves as a gateway to other services and types of transactions where money changes hands. We can then see how Apple benefits from the upside of what this hardware will enable. This is exactly how I feel we have to view any hardware Apple will release that is not a computer small, medium, or large.

Of course these hardware products from Apple may run a proprietary OS, and even iOS in the case of Apple TV, but we can’t let the reality slip that those products are not computers the same way the iPhone, iPad, or Mac are. Outside of that core, iOS is the center, not the hardware endpoint.

One last point. Apple being fully integrated across hardware, software, and increasingly services puts them into a position to benefit financially from all three — in some ways more than any competitor. For example, even though a health and fitness wearable, or even Apple TV, is a gateway to software and services upside, with iOS at the center, Apple can still get margins on hardware in ways others can’t. While the margins may not be as great as their computing products, they can still make some money on the hardware. My point, however, is it won’t be enough to make a blip on the revenue radar without that hardware also leading to revenue upside on software and services. Thus the margins and revenue upside is diversified across all three vectors — hardware, software, and services.

Going forward, we are dealing with new economies of scale in terms of growth. Selling high margin, high ASP products will simply hit a wall at some point in time as it saturates and you run out of customers. Relying on the hope new customers will emerge in the high end is too unpredictable of a variable to count on. Lower cost products is the surest way to grow into the mass market. Tablets, Macs, TVs, health and fitness wearables, and even a smartwatch are not subsidized products. Selling them at extremely high cost, like the iPhone, is simply not an option in many markets. ((Of course, there are options in some markets where retailers will offer payment plans thus bringing tablets, and wearables, into the subsidy ecosystem. But this again is a variable and brings with it competitive complications as well.)) Lower cost products require significantly higher volumes. No product Apple can launch will be like the iPhone. That is why what I lay out is the key to thinking about Apple’s hardware going forward. It’s more about iOS at the center than hardware endpoints at the center. This is the fundamental building block to a an ecosystem that can deliver growth and revenue across the hardware, software, and services spectrum.

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Ben Bajarin

Ben Bajarin is a Principal Analyst and the head of primary research at Creative Strategies, Inc - An industry analysis, market intelligence and research firm located in Silicon Valley. His primary focus is consumer technology and market trend research and he is responsible for studying over 30 countries. Full Bio

13 thoughts on “A New Way to Think About Apple’s Hardware Business”

  1. Lock-in is good for Apple, neutral to bad for the consumer. Lock-in can be prone to high impact disruptions. It wouldn’t be too far a stretch to envision the EU passing law requiring media compatibility (books, movies), or control system interoperability (cars, thermostats). If the EU can do it with mobile chargers, why not these things?
    Secondly, this war can’t be won without controlling the enterprise. BYOD has accommodated iOS, but it’s just that, an accommodation. People didn’t buy PC’s out of fandom, but because it’s what they used at work and fully interoperated with their work machines. I also don’t see corporate America abdicating the control they desire over their computers to be so dependent on iOS. You need to be “allowed” to program for it after all (with a revocable Developer License). Of course, I could be wrong.

    1. I was on a panel with the CTO of Chevron a few weeks ago at an IT conference focused on Apple and some of the insights were very interesting. This fellow, along with many other Fortune 500 CIOs and CTOs I talk to echo the same feedback around Apple which is generally good. Its becoming more than BYOD at this point. Chevron is deploying 30,000 iOS devices all purchased by corporate for field work. Apple has also been taking important steps to make their devices easier for enrollment and policy management by IT.

      So while I overall agree with your premise, all the evidence I see from the IT landscape is that Apple is not going away and is growing in its central importance to enterprises around the globe.

      Mobile changes everything, as I pointed out. 🙂 Desktop paradigms are changing and heterogeneity in the enterprise is becoming a mainstream standard. Still issues but there are on both sides of the camp not just Apple’s.

      But, my article was much more focused on consumer markets than commercial ones in the points I hit around Apple’s future hardware plans.

      1. Thanks for your considered response. The points I made were consumer geared. Lock-in directly impacts the consumer and, as the PC showed, IT can drive the consumer market. That iPads are being deployed today, is a broad, non-central, and ultimately replaceable approach.
        That this impacts all players is true. Tablets, especially the iPad, are highly managed devices, from the get go. I still don’t see IT abdicating the control they demand, to the control Apple demands. at least on critical aspects.

        1. I sort of agree with lock-in but as I point out, Apple can address this with a best with iOS strategy. They can’t make all the hardware to cover the gamut of the IoT landscape so they have to do this anyway. Make their software and endpoints the center of the broader ecosystem.

          Also, from what I hear IT has a love / hate with pretty much everyone so no different with Apple. The bigger question in my mind, which I will probably write about at some point, is whether or not Apple even cares about the enterprise.

        2. In the age of the PC, Yes, Corporate IT did drive many people to purchase PC’s for their homes as many people wanted to be able to be compatible with their offices and it is what they knew. I assisted many workers connecting from home or remote offices via Virtual Private Networks so they needed to have systems that could run both their home and their office. As most offices where using Windows that is what people purchased at home. Plus they did have some support from their corporate IT departments so many users where able to work over the rough spots on Windows.

          Things are much different now. The consumer market is driving many of the purchasing decisions now that we have iOS devices that are more like appliances than computers that require insane levels of management and control. We are looking at a much larger market of consumers (1 Billion phones sold every year globally IIRC) that corporate buyers (I am sure Ben has the numbers) so serving them and looking at corporate IT departments as just another type of user is the correct way for Apple to be looking at the world.

  2. you raise some good point with regard to Apple, but for this to work as you imagined, Apple will have to protect and preserve the status quo or current paradigm which is very beneficial for them, since they are the one who invented this pace.
    but as we all know, things never stay the same very long in business.
    sooner or later, just like Apple reinvented the mobile industry or computers with touch screen and App, other players are thinking of a way to reinvent it again, but this time perhaps with the cloud or something more advanced than what we have at the moment that we cannot even imagine, which could disrupt Apple’s business model, Hence the reason why I am a little bit skeptical about their future as the leader of the industry, until proven otherwise.

    P.S: Remember not too long ago just as you believe that IOS is the hub of the computer in our life, all analysis, pundit, technologist or business leader thought it’ll be PC until something unimaginable happened with the introduction of the IPhone

    1. To your PS. My firm actually did predict the shift from the PC as a hub to the smartphone. We also predicted the PC as the hub in our reports before Apple or anyone started using that philosophy. We actually have a storied past of predicting trends dating all the way back to desktop publishing. So we know a thing or two about this industry 🙂

      If you read why I wrote last week about how mobile changed everything then you know I’m already thinking about how everything can and will inevitably change. That being said, Apple can still play the premium end game and still thrive, and be profitable. This is due to the massive economies of scale we are talking about in this industry. But I do think they have more mass market ambitions than that.

      The key to take a long view of a company is to look at their culture, their willingness to change and adapt, their ability to spot trends, disrupt themselves, and stay in search of the next big thing. Some companies can do this and some can not. People seem to believe Apple can not but they have proven they are willing to change, adapt, and deliver products the market wants when it is ready. Apple doesn’t need to be first in all things and in most cases is not. They walk in with their process when they are ready.

      We know there will be a new cycle at some point in time in the future. Nothing is settled in mobile and more, they only thing we look at are the companies that exist today and whether they can serve the future or not.

      1. Ben, You are spot on about Apple. I think that Microsoft overplayed their hand and did not want until now to start to disrupt themselves. At least now we are seeing Microsoft start to think differently with the new CEO. Having Office on the iPad and offering Windows 8.1 for free to mobile OEMs is a big 1st step to looking at computing in 2014. Even Adobe is getting in on the act with the release of Lightroom for the iPad. I suspect that 2014 will be a big year for traditional desktop software to be coming to the iPad.

        However, Microsoft really did not get that end users where suffering from all the viruses and malware that has been a plague on PC’s sense the late 1990’s. They have had over a decade to clean up their mess and they just gave it lip service over that time while their end users where left high and dry. Sure we got Security Essentials and Windows Defender but they are band aids on a much larger issue.

        What Microsoft needed to do was to start over with a UNIX base and run classic Windows in a Virtual Machine. This could have been done the way that VMWare Fusion does their unity mode where it is seamless if you are running Windows or Mac OS X applications. Of course Microsoft would not have had to start from scratch on UNIX as they could have purchased one of the commercial UNIX and had a built in good developer support. Ultimately I predict that Windows desktop and server being virtualized will be run in a Virtual Machine as it is the best way to run Windows.

        As for Apple, they get that the end user must come 1st. Before everything and everyone else. This means that you have some developers will be upset that they can not get their app on iOS or some investors will not be happy with APPL as a stock as they may not look like they are moving fast enough by introducing products that do not go anywhere or waste money on big mergers. Apple knows that having money in the bank lets them do lots of things without having to ask Wall Street for permission if they need to. Plus it gives them a buffer to ride out any outside disruptions.

        On a side note, Just think of what Verizon could have done if they had the same cash on hand with the rollout of FIOS. I bet that many of us would have fiber internet now instead of being stuck with DSL or Cable. Wall Street really has a hard time looking long term beyond the quarterly results. One exception it seems to be Amazon. Wall Street seem to be giving them a pass for now but we will have to see how long that lasts.

  3. ” I do not believe any other company on the planet can do what Apple can do to benefit from such an integrated strategy. ”

    I disagree. From what I’ve been seeing so far from MS’ BUILD keynotes and blog posts, MS has all the pieces to be a formidable competitor to Apple. Whether they do or not will depend on how well they execute their vision and strategy. Windows Azure is light years ahead of iCloud and in some ways WP 8.1 looks more advanced than iOS. Never mind the fact that they still dominate the enterprise.

    I don’t think Apple is doomed but the mobile landscape just got that much more competitive.

    1. Using that logic their are a number of companies who can integrate like mentioned. Microsoft is one of them. Samsung is one of them. When Google bought Moto I thought they were going to be one of them. Huawei could do it, Xiaomi could do it, Amazon could do it, etc. But I strongly doubt any of them will, and for sure I don’t think they will integrate to the same degree that Apple will.

      The primary reason for this conviction is because integrated businesses are notoriously difficult to run. They are the most difficult company to run because it requires a culture, management philosophy, org chart and leadership team who can keep every integrated business working a common whole. Nearly every company on the planet is not built like this. But Apple was from the beginning.

      Every management book and business school case study I have read on the subject points out this point I am making. An integrated business is the first to fall apart if managed wrong. This is why Tim Cook is actually the right guy to run Apple.

      So while other companies can integrate on paper, they can not on the basis of current culture, management, etc. It would take a fundamental, inside out, re-organization of the enterprise to integrate and do so successfully. That is assuming they can find a person qualified, and with the skill sets to run an integrated company to lead the entire charge.

      1. Spot on. And not only is integration difficult, it is considered the wrong way to do it by many (most?) in the tech industry. Apple is seen as a mistake.

  4. Kind of, imo. Apple’s business is fully hardware and software in much the same way water is hydrogen and oxygen. Take one of those away and you don’t have water anymore. The services portion of Apple is still debatable. They have a lousy track record and iCloud, while better, still lacks anywhere near the depth of either the hardware or software offerings from Apple.

    Joe

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