Earnings Season: Headwinds and Drivers

We’re now most of the way through earnings season, at least as far as the biggest tech companies are concerned. It’s been an interesting one – some of the largest companies have posted disappointing results and seen their stock hammered for it while a smaller number have blown through expectations and seen their stock rise. As I’ve analyzed these companies, it’s become clear that a large part of what’s happened, not just this quarter but over the longer term, comes down to the headwinds each company faces, the drivers of growth it’s managed to tap into, and the balance between these two things. What’s interesting is, even though this is a fairly diverse set of companies, many of the headwinds and drivers are common across multiple companies. This analysis dives into these and suggests implications for the businesses and their future strategies.

Headwinds

The major headwinds in evidence this quarter include:

• Currency fluctuations, especially the devaluation of other currencies relative to the US dollar
• Maturity and/or decline in major established consumer hardware categories – PCs, tablets, and smartphones
• The US shift from subsidized devices to smartphone installment plans, which is slowing sales in US and bifurcating the market between cheap and premium
• The growth of Chinese smartphone brands
• The increasing strength of local competitors
• The decline in consumer willingness to pay for software
• The shift of ad spend from desktop to mobile and the associated lower prices, along with a more fragmented opportunity
• The move away from one-off purchases for content

These headwinds have affected different companies in different ways. The table below presents a simplified version of how they map onto a set of major tech companies. The simple checkmarks mask different degrees to which these companies were affected by these factors, but we’re going to stay at this high level for the purpose of this post:

As you can see, some of the companies that suffered the most this quarter are those which are suffering from the greatest headwinds, including Apple and Microsoft. On the other hand, there are companies, such as Twitter, which aren’t necessarily suffering from many of these headwinds, but are suffering more from internal problems, such as the lack of user growth and the inability to drive sufficient scale to attract advertisers.

Drivers

On the other hand, there are also several common drivers that affect these companies. These include:

• The explosion of enterprise cloud services and, to a lesser extent, consumer cloud services
• The growth of subscription content services
• The ongoing expansion of the mobile market
• The shift from search advertising on desktop to native/in-stream advertising on mobile
• New consumer hardware categories including wearables, home automation, and VR/AR

And again, these helped various companies to differing degrees this quarter as well:

Here, too, some of the companies that did the best this quarter have some of the biggest drivers working in their favor, notably Facebook. However, you can also see the two companies that struggled a little this quarter – Alphabet and Apple – also have several drivers working in their favor.

Balance

Ultimately, long-term results aren’t about the number of either headwinds or drivers working for or against each company, but the balance between these forces acting on the different parts of their business.

Microsoft has struggled over the last several years because significant parts of their business are suffering from several major headwinds, notably the broad shift to mobile, the maturity and decline of PCs, and consumers’ increasing unwillingness to pay for software, while only benefiting from one major driver: cloud services growth. Facebook is doing well because it has latched onto several major drivers, including the explosion of the mobile addressable market and the growth of native mobile advertising, and is exposed to few of the headwinds that affect companies with large legacy businesses. Apple is particularly interesting here because it is exposed to several of the major headwinds in a big way, most importantly the increasing maturity of the three major device markets in which it competes – PCs, tablets, and smartphones – but has managed to grow anyway by taking share in at least two of these markets. This quarter was markedly different because it was the first time Apple failed to grow any of these three businesses. A big question for Apple is whether it can continue to grow any of these businesses over the long term as the markets they’re part of begin to stagnate and decline.

For those businesses that are struggling, the key is to find ways to latch onto the major drivers of growth where they’re not yet benefiting, in ways that complement and fit with their existing businesses. Companies can’t instantly create decent-sized mobile native advertising businesses, but there may be ways to launch or acquire capabilities in, say, wearables, or subscription content services that can help to drive growth. A few of the headwinds and drivers are directly tied to each other in that they’re two sides of the same coin, and some companies may consequently benefit from increasing their exposure to the upside of some of the drivers as a hedge against the downside risk associated with some of the headwinds. Individual earnings seasons come and go but, in the long term, companies’ ability to thrive and please their shareholders will depend on their success in achieving a proper balance between drivers of growth and the headwinds they’ll inevitably face.