Apple's Strategic Dilemma
January 28, 2019
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After a heady run, Apple has been a pitiful performer over the past times several months, as well as has de-rated to levels that guide hold started to attract value investor interest. Peters-McGregor, for instance, lately purchased shares, outlining all the traditional strengths the bulls guide hold historically identified amongst Apple (brand, client lock-in, growing services), as well as that the stock is right away on only 13x (and 11-12x ex cash).
They mightiness last right, but to my mind, Apple is facing a number of rapidly-growing strategic issues that are non going to last easily soluble inwards coming years, as well as so I'm non convinced the stock is cheap. It also needs to last remembered that the historical strengths identified past times the bulls are already reflected inwards the company's lofty operating margins, so applying a high multiple to those rattling high profits does come upward amongst the endangerment of 'double counting'.
The kickoff number Apple faces is a maturing global smartphone marketplace - non just inwards terms of penetration (most people inwards the dry ground right away guide hold a smartphone, as well as those that don't are the world's poorest as well as volition in all probability purchase a inexpensive Chinese build every bit their entry-point), but also inwards terms of the character of the production itself. There is a maxim inwards the dry ground of devices/appliances - "in the long run, everything is a toaster" (i.e. everything becomes commoditised as well as incapable of farther functional improvement). With each generation of iPhone, it is getting harder as well as harder to come upward up amongst meaningfully improved features that justify customers apace upgrading - especially at higher as well as higher prices.
Back inwards the days of the iPhone 3, each novel generation of phones was a step-change inwards terms of improved functionality. Today, each novel generation simply contains tike enhancements. The learning flexure is flattening out, as well as it in all probability won't last long until each novel generation is barely amend than the prior i at all. I lately bought a iPhone X after previously having an iPhone 6s, as well as frankly, piece it is better, it's non that much better.
Now, I admit client loyalty rates are high, as well as that customers' wishing to non lose access to their prior app purchases acts every bit an of import origin of consumer lock-in. The value offered past times a >US$1k telephone is also high on a per-hour-of-use basis, given how much value nosotros exit of our phones, as well as how oftentimes nosotros exercise them. Retention rates are hence probable to stay high. However, this high retentiveness charge per unit of measurement notwithstanding, what this production maturity agency is that replacement cycles are going to lengthen. Instead of upgrading every 1-2 years, Apple fans are in all probability going to start upgrading every 4-5, or perchance fifty-fifty longer inwards time. This could conceivably cutting Apple's global sales book inwards one-half inwards coming years, fifty-fifty if client retentiveness rates stay high.
Perhaps recognising this, Apple has tried to instead focus on raising prices as well as farther premiumising, hoping to compensate for falling volumes amongst higher margins. But recent sales trends dot that they may already last approaching the practical boundary of this strategy - i.e. the dot where it is self-defeating inwards that it just farther lengthens the replacement cycle. Tellingly, the companionship both missed calendar 4Q revenue expectations (pre-announced before this year), as well as also lately announced an intention to halt providing the marketplace amongst iPhone sales book data. This tin only last interpreted every bit a sign that volumes guide hold peaked, as well as that Apple expects them to reject precipitously.
Reflecting this peaking-out inwards hardware earnings, the companionship is pivoting to 'services', as well as has been careful to scream from the rooftops close rapid ongoing increment inwards services revenue. The companionship wants investors to halt seeing it every bit a hardware company, as well as sentiment it every bit a toll-booth company, where it's large installed base of operations of devices (some 1.4bn) are basically an 'electronic storefront' that promises to last a perpetual cash machine every bit customers purchase to a greater extent than as well as to a greater extent than apps/in-app purchases over time, every bit smartphones are increasingly used to exercise everything (this, I believe, is what Buffett saw, inwards conjunction amongst high client loyalty).
But hither is the problem: there is an inherent strategic tension betwixt trying to run a occupation organisation model that focuses on having an electronic shop front end inwards front end of everyone's nose, as well as a hardware strategy that focuses on having an exclusive, premium production that only a minority of the dry ground tin afford. If you're going for the razor as well as razorblade model, yous wishing everyone to guide hold a razor, as well as yous wishing to sell those razor's cheaply, so everyone has one. That's what Google has been doing inwards giving away its Android OS for free. They wishing to sell razorblades (apps, every bit good every bit secure wagon for their browser as well as search engine).
However, past times pushing for to a greater extent than as well as to a greater extent than premium prices on its hardware/OS bundle, Apple is limiting its potential puddle of razorblade sales. This is truthful of both third-party as well as first-party services. For third-party apps, yous boundary the breadth of your storefront, piece for first-party services, yous endure from diseconomies of scale vs. competing providers that target both iOS as well as Android users. This is i argue Apple Music has been losing dry ground to Spotify. Spotify's target marketplace is the entire world, non just iPhone users, which gives them a structural advantage.
Now, that doesn't hateful 1.4bn Apple device users are going to of a precipitous abandon them. They tin notwithstanding guide hold a squeamish occupation organisation selling apps to their existing user base. But fifty-fifty this occupation organisation is in all probability non likewise far away from maturity, inwards the absence of a growing user base. The average device already makes to a greater extent than than US$30/year inwards app purchases (US$45bn inwards services revenue on 1.4bn devices), as well as every bit fourth dimension goes by, consumers volition increasingly guide hold plenty apps providing plenty services, as well as the stride of novel app purchases volition probable laid out to degree off, or fifty-fifty decline.
However, it get's worse. Apple takes 30% of all sales conducted through its app-store, as well as at that topographic point are just about potential line per unit of measurement area points/risks to the sustainability of this. For a start, at that topographic point are antitrust risks, as well as at that topographic point is currently already a representative proceeding through the Supreme Court. Microsoft was heavily fined as well as censured inwards the piece of cake 1990s for abusing its marketplace position, inwards having a monopoly operating organisation that it used to force Netscape Navigator browsers out of the market, inwards favour of its ain Internet Explorer.
While the province of affairs amongst Apple is non just analogous (Android phones are to a greater extent than numerous than iOS powered phones), at that topographic point are just about similarities. Apple is charging Google US$9bn a twelvemonth to build Google the default search engine for Safari (vs. just US$1bn inwards 2014). That is arguably equivalent to Microsoft charging Netscape Navigator a fortune to last the default browser inwards Windows. And Apple is also denying its users access to many apps unwilling to pay the 30% toll fee. Many people believe 30% is an unreasonably high cut, as well as that Apple has likewise much marketplace powerfulness to unilaterally laid this rate. The political zeitgeist is starting to plow against big-tech, so regulation/anti-trust is a growing risk.
Furthermore, Epic Games - next its huge striking amongst Fortnite - has assembled just about 200m user accounts, as well as is leveraging that user base of operations to create its ain storefront for a diversity of games/apps, where it promises to accuse only 12%. When it lately launched a mobile version of its striking game Fortnite, it announced that it would non last selling the app through either the Apple or Google Play store, but rather through its ain online shop & billing set-up. Both Netflix as well as Spotify guide hold also evaded Apple's 30% cutting past times having users sign upward on their ain websites, rather than pay through the Apple App store. These apps guide hold been likewise pop for Apple to block, every bit has Fortnite, as well as doing so would endangerment raising the ire of antitrust regulators inwards whatever case. In addition, at that topographic point guide hold also been just about intelligence reports that Google has decided reduced its ain take-rate on apps purchased inwards its Google Play shop inwards answer to emergent contest from app stores such every bit Epic.
So hither is the potential work for Apple's services business: Sales could start to migrate off its app shop onto other platforms such every bit Epic's, who guide hold only a 12% cut, as well as if they block such apps, they endangerment anti-trust retribution. But fifty-fifty if antitrust was non an issue, it could guide hold negative consequences, because if Google Play was to jibe Epic's 12% take-rate (or simply non block such apps), it would hateful that non only would Android users potentially savour lower prices on app-store purchases, but that it would also cash inwards one's chips far to a greater extent than profitable for developers to railroad train as well as distribute apps via Android than Apple every bit well.
Given that Android's user base of operations is larger than Apple's, Android-compatible apps would potentially start to last given priority past times developers. This has by as well as large non been the representative to appointment (Google Play took 30% every bit well), as well as Android was non given priority. Steve Balmer famously screamed "developers, developers, developers, developers, developers, developers...." for a reason. You postulate a lock on developers to maintain a lock on people using your operating organisation (and inwards Apple's case, the bundled device).
If platforms similar Epic starts to cash inwards one's chips a storefront used to access as well as pay for a broad diversity of games as well as other apps, it is going to last rattling difficult for Apple to block access to them all, if they are pop as well as available on Android. And what if Epic says, yous tin only access these apps on an all or nix basis? Want Fortnite? You postulate to guide hold everything else every bit well, as well as non accuse for carriage. And if Apple says no, they opened upward themselves upward to antitrust concerns.
Customer loyalty to Apple has been high inwards the past times for many reasons, but i of the reasons has been because the App Store had virtually every app customers mightiness want, as well as at a similar cost to competing platforms. But if that changes, as well as Android phones guide hold a wider diversity of apps, available sooner, as well as at lower cost points, at to the lowest degree just about of Apple's customers could start guide hold instant thoughts.
Lastly, the 'freemium' model is growing inwards popularity - yous laissez passer on the app away for costless as well as so attempt to accuse for ad-ons subsequently - as well as amongst this model, it is inherently easier to direct customers to your website to sign upward as well as pay for ad-ons, rather than doing it straight through the Apple store. And every bit just about of these freemium platforms grow as well as furnish to a greater extent than as well as to a greater extent than services within them, less as well as less exclusively novel apps are required/demanded past times customers. This has already happened amongst WeChat inwards China, for instance, which has cash inwards one's chips the portal consumers exercise to access a broad diversity of other services. When this happens, the phone's app shop is effectively disintermediated.
I'm thinking out loud here. I'm non an Apple expert, as well as I'm non short, as well as nor would I cash inwards one's chips brusk at electrical flow prices. I'd in all probability truly rather cash inwards one's chips long than brusk at electrical flow prices if I absolutely had to option i side (which I don't). The stock is non just expensive, so I don't think the risk-reward is asymmetric. However, I'm non convinced the stock is inexpensive given these diverse risks/issues. If both hardware sales as well as services revenue cash inwards one's chips into reverse, at that topographic point is a lot of potential downside.
Comments welcome,
LT3000
They mightiness last right, but to my mind, Apple is facing a number of rapidly-growing strategic issues that are non going to last easily soluble inwards coming years, as well as so I'm non convinced the stock is cheap. It also needs to last remembered that the historical strengths identified past times the bulls are already reflected inwards the company's lofty operating margins, so applying a high multiple to those rattling high profits does come upward amongst the endangerment of 'double counting'.
The kickoff number Apple faces is a maturing global smartphone marketplace - non just inwards terms of penetration (most people inwards the dry ground right away guide hold a smartphone, as well as those that don't are the world's poorest as well as volition in all probability purchase a inexpensive Chinese build every bit their entry-point), but also inwards terms of the character of the production itself. There is a maxim inwards the dry ground of devices/appliances - "in the long run, everything is a toaster" (i.e. everything becomes commoditised as well as incapable of farther functional improvement). With each generation of iPhone, it is getting harder as well as harder to come upward up amongst meaningfully improved features that justify customers apace upgrading - especially at higher as well as higher prices.
Back inwards the days of the iPhone 3, each novel generation of phones was a step-change inwards terms of improved functionality. Today, each novel generation simply contains tike enhancements. The learning flexure is flattening out, as well as it in all probability won't last long until each novel generation is barely amend than the prior i at all. I lately bought a iPhone X after previously having an iPhone 6s, as well as frankly, piece it is better, it's non that much better.
Now, I admit client loyalty rates are high, as well as that customers' wishing to non lose access to their prior app purchases acts every bit an of import origin of consumer lock-in. The value offered past times a >US$1k telephone is also high on a per-hour-of-use basis, given how much value nosotros exit of our phones, as well as how oftentimes nosotros exercise them. Retention rates are hence probable to stay high. However, this high retentiveness charge per unit of measurement notwithstanding, what this production maturity agency is that replacement cycles are going to lengthen. Instead of upgrading every 1-2 years, Apple fans are in all probability going to start upgrading every 4-5, or perchance fifty-fifty longer inwards time. This could conceivably cutting Apple's global sales book inwards one-half inwards coming years, fifty-fifty if client retentiveness rates stay high.
Perhaps recognising this, Apple has tried to instead focus on raising prices as well as farther premiumising, hoping to compensate for falling volumes amongst higher margins. But recent sales trends dot that they may already last approaching the practical boundary of this strategy - i.e. the dot where it is self-defeating inwards that it just farther lengthens the replacement cycle. Tellingly, the companionship both missed calendar 4Q revenue expectations (pre-announced before this year), as well as also lately announced an intention to halt providing the marketplace amongst iPhone sales book data. This tin only last interpreted every bit a sign that volumes guide hold peaked, as well as that Apple expects them to reject precipitously.
Reflecting this peaking-out inwards hardware earnings, the companionship is pivoting to 'services', as well as has been careful to scream from the rooftops close rapid ongoing increment inwards services revenue. The companionship wants investors to halt seeing it every bit a hardware company, as well as sentiment it every bit a toll-booth company, where it's large installed base of operations of devices (some 1.4bn) are basically an 'electronic storefront' that promises to last a perpetual cash machine every bit customers purchase to a greater extent than as well as to a greater extent than apps/in-app purchases over time, every bit smartphones are increasingly used to exercise everything (this, I believe, is what Buffett saw, inwards conjunction amongst high client loyalty).
But hither is the problem: there is an inherent strategic tension betwixt trying to run a occupation organisation model that focuses on having an electronic shop front end inwards front end of everyone's nose, as well as a hardware strategy that focuses on having an exclusive, premium production that only a minority of the dry ground tin afford. If you're going for the razor as well as razorblade model, yous wishing everyone to guide hold a razor, as well as yous wishing to sell those razor's cheaply, so everyone has one. That's what Google has been doing inwards giving away its Android OS for free. They wishing to sell razorblades (apps, every bit good every bit secure wagon for their browser as well as search engine).
However, past times pushing for to a greater extent than as well as to a greater extent than premium prices on its hardware/OS bundle, Apple is limiting its potential puddle of razorblade sales. This is truthful of both third-party as well as first-party services. For third-party apps, yous boundary the breadth of your storefront, piece for first-party services, yous endure from diseconomies of scale vs. competing providers that target both iOS as well as Android users. This is i argue Apple Music has been losing dry ground to Spotify. Spotify's target marketplace is the entire world, non just iPhone users, which gives them a structural advantage.
Now, that doesn't hateful 1.4bn Apple device users are going to of a precipitous abandon them. They tin notwithstanding guide hold a squeamish occupation organisation selling apps to their existing user base. But fifty-fifty this occupation organisation is in all probability non likewise far away from maturity, inwards the absence of a growing user base. The average device already makes to a greater extent than than US$30/year inwards app purchases (US$45bn inwards services revenue on 1.4bn devices), as well as every bit fourth dimension goes by, consumers volition increasingly guide hold plenty apps providing plenty services, as well as the stride of novel app purchases volition probable laid out to degree off, or fifty-fifty decline.
However, it get's worse. Apple takes 30% of all sales conducted through its app-store, as well as at that topographic point are just about potential line per unit of measurement area points/risks to the sustainability of this. For a start, at that topographic point are antitrust risks, as well as at that topographic point is currently already a representative proceeding through the Supreme Court. Microsoft was heavily fined as well as censured inwards the piece of cake 1990s for abusing its marketplace position, inwards having a monopoly operating organisation that it used to force Netscape Navigator browsers out of the market, inwards favour of its ain Internet Explorer.
While the province of affairs amongst Apple is non just analogous (Android phones are to a greater extent than numerous than iOS powered phones), at that topographic point are just about similarities. Apple is charging Google US$9bn a twelvemonth to build Google the default search engine for Safari (vs. just US$1bn inwards 2014). That is arguably equivalent to Microsoft charging Netscape Navigator a fortune to last the default browser inwards Windows. And Apple is also denying its users access to many apps unwilling to pay the 30% toll fee. Many people believe 30% is an unreasonably high cut, as well as that Apple has likewise much marketplace powerfulness to unilaterally laid this rate. The political zeitgeist is starting to plow against big-tech, so regulation/anti-trust is a growing risk.
Furthermore, Epic Games - next its huge striking amongst Fortnite - has assembled just about 200m user accounts, as well as is leveraging that user base of operations to create its ain storefront for a diversity of games/apps, where it promises to accuse only 12%. When it lately launched a mobile version of its striking game Fortnite, it announced that it would non last selling the app through either the Apple or Google Play store, but rather through its ain online shop & billing set-up. Both Netflix as well as Spotify guide hold also evaded Apple's 30% cutting past times having users sign upward on their ain websites, rather than pay through the Apple App store. These apps guide hold been likewise pop for Apple to block, every bit has Fortnite, as well as doing so would endangerment raising the ire of antitrust regulators inwards whatever case. In addition, at that topographic point guide hold also been just about intelligence reports that Google has decided reduced its ain take-rate on apps purchased inwards its Google Play shop inwards answer to emergent contest from app stores such every bit Epic.
So hither is the potential work for Apple's services business: Sales could start to migrate off its app shop onto other platforms such every bit Epic's, who guide hold only a 12% cut, as well as if they block such apps, they endangerment anti-trust retribution. But fifty-fifty if antitrust was non an issue, it could guide hold negative consequences, because if Google Play was to jibe Epic's 12% take-rate (or simply non block such apps), it would hateful that non only would Android users potentially savour lower prices on app-store purchases, but that it would also cash inwards one's chips far to a greater extent than profitable for developers to railroad train as well as distribute apps via Android than Apple every bit well.
Given that Android's user base of operations is larger than Apple's, Android-compatible apps would potentially start to last given priority past times developers. This has by as well as large non been the representative to appointment (Google Play took 30% every bit well), as well as Android was non given priority. Steve Balmer famously screamed "developers, developers, developers, developers, developers, developers...." for a reason. You postulate a lock on developers to maintain a lock on people using your operating organisation (and inwards Apple's case, the bundled device).
If platforms similar Epic starts to cash inwards one's chips a storefront used to access as well as pay for a broad diversity of games as well as other apps, it is going to last rattling difficult for Apple to block access to them all, if they are pop as well as available on Android. And what if Epic says, yous tin only access these apps on an all or nix basis? Want Fortnite? You postulate to guide hold everything else every bit well, as well as non accuse for carriage. And if Apple says no, they opened upward themselves upward to antitrust concerns.
Customer loyalty to Apple has been high inwards the past times for many reasons, but i of the reasons has been because the App Store had virtually every app customers mightiness want, as well as at a similar cost to competing platforms. But if that changes, as well as Android phones guide hold a wider diversity of apps, available sooner, as well as at lower cost points, at to the lowest degree just about of Apple's customers could start guide hold instant thoughts.
Lastly, the 'freemium' model is growing inwards popularity - yous laissez passer on the app away for costless as well as so attempt to accuse for ad-ons subsequently - as well as amongst this model, it is inherently easier to direct customers to your website to sign upward as well as pay for ad-ons, rather than doing it straight through the Apple store. And every bit just about of these freemium platforms grow as well as furnish to a greater extent than as well as to a greater extent than services within them, less as well as less exclusively novel apps are required/demanded past times customers. This has already happened amongst WeChat inwards China, for instance, which has cash inwards one's chips the portal consumers exercise to access a broad diversity of other services. When this happens, the phone's app shop is effectively disintermediated.
I'm thinking out loud here. I'm non an Apple expert, as well as I'm non short, as well as nor would I cash inwards one's chips brusk at electrical flow prices. I'd in all probability truly rather cash inwards one's chips long than brusk at electrical flow prices if I absolutely had to option i side (which I don't). The stock is non just expensive, so I don't think the risk-reward is asymmetric. However, I'm non convinced the stock is inexpensive given these diverse risks/issues. If both hardware sales as well as services revenue cash inwards one's chips into reverse, at that topographic point is a lot of potential downside.
Comments welcome,
LT3000