Understanding Apple Part 2

on October 27, 2013

If you follow Apple in the press and talk to analysts, you’re probably confused. There are three conflicting narratives being presented: Apple is doomed, Apple is disappointing, or Apple is dominating. So many journalists have written about Apple’s lack of innovation without Steve Jobs that, “Apple is doomed,” has almost become a meme. Most financial analysts are in the “Apple is disappointing” camp – the P/E ratio of Apple’s stock price is certainly depressed relative to the competition, yet market analysts – including yours truly – describe Apple as clearly dominant. How can all these be true?

Part 1 of this article covered how Apple is Doomed and Apple is Disappointing.

Apple is Dominant

On the whole, I have found market analysts to be far more positive on Apple’s position than financial analysts. At Current Analysis, Apple garners the highest scores possible in every category except “Partnerships.” Most market analysts focus on the competitive impact of Apple’s products and strategy, not the stock price. Apple is dominating the most profitable segment of the market. If you are a vendor competing with Apple, what matters is whether you can profitably sell products against them. Samsung can. Everybody else is losing money, treading water, or is selling hardware as a loss leader to make money some other way.

Moreover, Apple’s ability to profit in the future seems clear. Apple has a reputation for secrecy, but its product development strategy is transparent. It develops products in markets adjacent to its existing products, and builds on the investments it already has in software and services platforms – OS X/iOS, iTunes, the App Store, and iCloud. Apple often takes advantage of new component technologies to enter new markets, but it designs the product around a specific – and limited – set of use cases rather than building something because the technology enables it to be built.

When it comes to creating new markets or taking an early adopter market and making it mainstream, Apple is in rare company. There are not many companies that can integrate technology and design on top of existing software and services platforms; it helps if you control the ecosystem, and building one from scratch is terribly hard. Apple will certainly have competitors in any market it enters, but the bigger danger is choosing the wrong set of problems to solve. This is the area where Steve Jobs’ absence is the biggest loss – Jobs seemed to have an unerring eye for what could be left out of a product and still be left with a compelling version 1.0 product. Apple is fortunate that its executive staff has had relatively low turnover – many of the people who helped Jobs make those choices are still at the company and are working on new products today. I do not pretend to know what those products are. Wearables and living room devices certainly fit nicely in Apple’s ecosystem, but Apple could be working on something else entirely.

Apple also has more room to grow its phone and tablet business. Global distribution can be expanded further – Apple still has room to appeal to upper income users in China and India. Over time, the iPhone 5C should drop in price somewhat, enabling upper middle class consumers in emerging markets to buy in. In developed markets, there is still plenty of room for late adopters who are still using featurephones today. This group will not be kept away by the high price of the iPhone because carriers distort the true cost of the phones with subsidies. Even after the iOS 7 refresh, the iPhone still has the simplest user interface of any smartphone, which should be appealing to late adopters, especially technophobes.

Apple could also expand the size of the iPhone to appeal to the segment of the market that can afford an expensive phone, but wants a larger display than Apple offers. This product category has more appeal in Asia than in the West, but Samsung has sold 37 million Galaxy Notes, and Apple is certainly paying attention. I expect Apple to address this market eventually, though it is taking a long time doing so. My guess is that the sticking points are finding a form factor that is manageable while still whetting the appetite for a larger display, and picking a display that doesn’t impose screen resolution fragmentation costs on developers.

Pad sales growth is down, but new models could change that. The iPad Air reinvigorates Apple’s full sized offering, and the retina iPad mini takes away a key differentiator of small Android and Windows tablets. Apple has all but telegraphed that Touch ID is coming to an iPad near you – and your IT manager – with the next update.

Three Narratives

That is how we ended up with such divergent narratives in the press and analyst communities. Journalists are reporting on whatever is deemed newsworthy – and launching incremental improvements is not exciting, even if it is wildly successful. Financial analysts are trying to assess Apple’s future profit growth without betting on Apple being successful in markets that don’t exist. Some of them also don’t trust that Apple’s current profit level is sustainable, even if they don’t actually question Apple’s market dominance in the slightest. Market analysts look at Apple’s platform and see possibilities where it could be extended. In the meantime, Apple’s strategy of selling a lot of phones and tablets and making a lot of money on them seems fundamentally sound.