Alright let Faultline be the first one in the room to point at Apple’s figures and to ask ‘Yeah, but for how long?’ The problem with asking question like that is you have to then answer them and it’s a tough call.
We are old. We even remember when DEC was an upstart and IBM was the most profitable company in the world, and likely to grow into the biggest. It never happened. Along came Microsoft. We also remember when Dell was going to be the next company past $100 million on current course, and it never happened, along came the dotcom bust, a recession and the potential de-emphasis and devaluation of the PC.
Even Microsoft’s reign has been tough to predict and many feel that it is not yet over. But it is. That doesn’t mean investors should run for the hills, it remains a blue chip stock, or rather has become one, but it has fallen in value over the past ten years, and in the next ten, it will never again compete with the new generation of high-tech power brokers. One of the clues of ‘maturity’ is when a company begins issuing dividends or buying back its own shares. It means it cannot think of anything better to do with its money.
If stock options are offered to Microsoft workers they genuinely have to ask, ‘Will they ever be worth anything,’ and geniuses everywhere look to belong to Apple or Google, where the stock price still surges.
The problem with predicting Microsoft’s fall was that it continued, improbably to continue to hold sway in two core markets ‘ PC software and server software (though it was less dominant there) in a hegemony that began in the mid-1980s. Nothing could shift it. In the PC era, everyone wanted to make their fortune out of writing software for ONE platform. In the end few of these remained alive as Microsoft went after each software area, one by one and absorbed it like the Borg. So while some people became rich, many just made a living. Anti-virus companies and Adobe are the exceptions which survived, while word processing giants like WordPerfect and browser companies like Netscape and spreadsheet companies like Lotus, and many other categories of software became ‘owned’ by Microsoft.
In the server area something similar happened. When Microsoft joined in all the Unix based companies ‘froze’ like rabbits in headlights. Once every IT department in the world had reset its price performance expectations from the massive costs of mainframe computing, to high end, multiprocessor PC chips, running open source OSs, Microsoft pulled off the trick of buying out the DEC OS development team, lock stock and barrel and they built NT (New Technology) which is the basis of the Windows server operating environment. Sure Microsoft paid $2 billion to DEC for embarrassing code similarities, but it was a drop in the ocean. Once again a few companies got rich in systems management and accounting software, but Microsoft strangled the bulk of the money out of this market in a tight draw with Sun, IBM and HP. What it had was secret sauce ‘ its client server architecture released ‘extra’ hidden power in the clients, until it was found out and the European anti-trust courts made Microsoft come clean about this and it lost much of its advantage in these markets. But not before it had bought in a sophisticated repository and linked this to its Exchange email server and dominated global corporate email.
At that point the company became retrograde and was no longer nice to its developer community or even its users. It made successive versions of consumer software ‘not work’ with previous versions of documents and files, it tried to bully its way into neighboring markets ‘ handsets, IPTV, games consoles, online services ‘ and none of these have been successful in the same way as its PC operating system. In almost every instance Microsoft failed because nobody wanted it to succeed ‘ but the IT departments of the world continued to buy Microsoft products in droves, because they were utterly dependent upon them. Stupidly IT department had never thought to keep a handy rival alive for competition.
Let’s face it, even when Linux came along, nobody trusted it on a PC and certainly your IT department wouldn’t. With the arrival of the internet, Word Documents, Excel spreadsheets and Outlook forced successive upgrades to products which did not do anything more than previous generations ‘ but if you did not upgrade, you could not read emails, documents and spreadsheets from other people. Microsoft product purchases became grudge purchases, which we could not avoid.
This seems to be the high tech formula, win a couple of wars, and then retire from innovation permanently and live off the proceeds of your first great inventions. So what can this teach us about Apple?
Well first off, Apple has a different kind of popularity. It is popular with consumers. This kind of popularity has far less long term appeal, but it has some. For instance you may want to throw away your iTunes and iPod and use your phone for music ‘ but some of the earlier tracks which were DRM encrypted ‘ some of which will be your favorites, just refuse to move. So you have to buy them again. Which sucks, so instead you buy an iPhone ‘ partly because you want to, but mostly because you HAVE to, in order to keep all your music.
But unlike corporations which made Microsoft rich, consumers do not have loyalty once a brand is tarnished, because they would rather be cool even if it means they have to shift their content from device to device. New Apple users are buying MP3 tracks without DRM, so they don’t face this problem.
Look at how Nokia is faring. Nokia was considered super-cool for years in most countries, but today it is losing the war against Apple despite a number of advantages ‘ it makes things cheaper and more sturdy than Apple. But once it has lost its ability to appear cool, it has lost ground dramatically. If Apple loses its coolness factor ‘ it will be discarded. Microsoft had the Chief Financial Officers of the world telling IT department to keep costs down, and that played into Microsoft’s hands because replacing all things Microsoft was way too hard. Consumers for the most part just don’t care.
The Nintendo DS was once considered cool. In fact it has been cool for a long time. It is probably the first device on which a child ever experienced the magic of wireless networking, as WiFi linked the devices together to swap game accessories. To a ten year old girl it was supercool to bring up their Nintendogs and swap things with their girlfriends.
But to the same girl at 13, it is an embarrassment, because it has no touch paradigm and all the kinds at school play far more sophisticated games on an iPod Touch. To the young, cool is thoroughly important and without any specialist gaming effort Apple has stolen away the portable gaming market, by simple use of its App Store.
But of course those who live by the sword, die by it, and by the same token Google’s Android is already looking to be every bit as cool as the iPhone, because it does all the same things, it offers the same capabilities with its Android Market and touch screens, but it has two things going for it, one important and one not so important ‘ the devices can all look a bit different, and so engage personal tastes, and the execution of some of the software in its market is simply better. Quite simply things like voice control and translation systems work better when bought on an HTC Android than on a iPhone. This has something to do with the quality of the developers it attracts, and of course the freedom it gives developers to use phone resources.
But there will continue to be a solid following of Apple and it has a kind of cool ‘After effect’ ‘ the iPhone is only just becoming cool in some parts of the world, but these parts, like China and India, happen to ship many times more devices than the US, which is just around 10% of the world’s cellular devices, although far more than that in terms of revenue.
So not only is the iPod, still untouched by rivals, the iPhone is still growing in popularity in many parts of the world. It is not time yet to predict the iPhone becoming uncool, even if it is pass’ in your neighborhood.
But the key indicators for Apple will be when its famous margins start to droop and when it no longer successfully invades any new markets. A single device cannot capture the imagination of a consumer audience for more than a few years unchanged. Doubters may raise the issue that the iPhone is already more than a few years old, but the first iPhone was unable to download very much at all, because it wasn’t 3G, the first 3G phone didn’t have enough memory, and the third iPhone was when the App Store really came to life. The 4th generation iPhone (ironically it uses 3G cellular technology only) is less of a leap, if it is any leap at all, in terms of innovation and it is selling purely because the device is sweeping up parts of the market that hadn’t yet been reached with previous versions ‘ in other words it is selling because it is many people’s first iPhone, not because iPhone 3G users are ditching their devices.
We don’t want to knock Apple just because it is successful, not after we have supported the company and pointed it to emerging as a CE force back in 2003 and 2004, when we first witnessed its arrival.
And sometimes a company seems to have run out of ideas because it has paused to complete the roll-out of the ideas it has already had. But there are glimpses of concern in the company results, which are, of course, the best it has ever had.
The two issues are ‘What has Apple left to achieve?’ and ‘What can it do to cement itself into markets so that fickle consumers cannot shake it off?’
Key to the areas which are left to for Apple to achieve is penetration of all entertainment markets, but especially the TV market. Forget Apple TV, it’s a failure. People have said that the device has sold out all that Apple has made, but it made so few, and what it has failed to do it change the economics of content delivery. There is a very good reason for this ‘ Steve Jobs always wants to control an entire eco-system from end to end. The App Store may not be that tough a place to conduct business, but Apple has far more strict rules than say Android Market. And the iPod would never have got off the ground had not iTunes music store been first to market by some time. The effort behind achieving that was a gamble of investment in mass market music licensing.
Apple is exceptionally brilliant at taking a gamble and that bold gambit approach ‘ facing off the record companies in its famous $0.99 pricing for tracks, forward buying of over $2 billion of Flash memory for its iPods, building an entirely new approach to touch screens, introducing tablets first ‘ will continue to serve it well. On many occasions it is the strength of its conviction that leads to economies of scale in its purchasing that leads to its massive margins.
What would it have done with that massive Flash memory mountain in 2005, had the iPod not managed the shift from hard drives to Flash memory? Well no doubt it would have sold it into the open market at a profit. But few other companies feel at home making such gambles. Today it is even more capable of making gambles given the money it has in its accounts ‘ around $26.5 billion and rising.
But right now Apple has no DVR on its books, no TV brand and its internet TV set top remains ‘uncool’ among customers despite its $99 price point ‘ and this is because the content proposition is expensive, even if the device is not.
Part of the reason for that is because studios have looked at the condition of the record labels and thought, ‘We won’t fall into the same trap’ and so they have proceeded to spread their favors around among Apple, Google and the other CE players and refuse to cut Apple privileged deals.
Where else will Apple look? Well it is clearly attacking the popularity of its core Mac desktops and laptops, back in the enterprise and also among consumers. In its fourth quarter results it sold 2.64 million Mac styled PCs at $4.87 billion. It reports these separately, but as an architecture they are the largest thing that Apple does today, except the iPhone, which brought in $8.8 billion in the quarter selling 14.1 million units.
Apple will also continue to spread itself around the world more fully and its numbers show a 157% increase in revenues over last year in Asia Pacific and 121% in Japan and even a 69% revenue hike in Europe, as it catches up with the US belief that Apple is cool, despite only growing 37% in the US. This will continue for some time, as these markets are very early in their cycle of buying Apple products.
Apple is not in a position to revolutionize the cinema, and right now has no product line in the sitting room to deliver TV and looks to have no leverage there.
Throughout the entertainment portfolio through which it attracts consumers, Apple will find that the rise and rise of DLNA will result in device features which make for simpler digital home communication and content sharing and these will arrive throughout the rest of the CE market, something that Google and Apple are both conspicuously not part of (see separate article on DLNA). This will lead to devices in the living room sharing content far more freely than before, with the obstacles of file formats, content codecs and cables and wireless modulations all eliminated.
Apple would tell you that they are already eliminated, all by the expedient of using purely Apple devices end to end. But that’s its proprietary lock-in mind thinking.
The truth is that history tells us that proprietary lock ins all come to an end, and they end in the same way ‘ when the wider environment offers open source and open networking and flatten margins. Unix did it to mainframes, and initially the PC (open in the sense that anyone could develop for it) did it to minicomputers, Linux (in the form of Android) is now doing it to tablets and set tops and phones
In order to look for new markets Apple will have to go into territories which are already occupied ‘ online advertising and online search would be two that are worthwhile so that all adverts on its devices and all searches on its devices can be turned to other revenues. But here it is not chasing the consumer, instead it is delivering the consumer to a service at which others are expert.
It still has the opportunity of developing an innovative Over The Top video proposition, but it’s had three goes at that and has still made no headway, and studios are aligned against it or at least a careful not to fall into a lock-in trap.
The reduced margins that Apple has suffered in this its best ever quarter are also indicative of how Apple has had to bow to rivals offering lower priced products.
It brought home its first ever $20 billion quarter at $20.34 billion, racing past the $12.21 billion it had in the year-ago quarter and beat its own guidance, racking up net profits of $4.3 billion, but its gross margin was 36.9% compared to 41.8% in the year-ago quarter and down from 39.1% percent in the previous quarter. Its margin is sliding and is under threat, as it both scales and as rivals aggressively chase and copy its achievements.
Which is perhaps why Steve Jobs has taken to knocking the competition and talking Apple up to the finance community. He attended the financial results conference call, something he rarely does, and talked about overtaking RIM in their most recent quarter, promising ‘We still have a few surprises left for the remainder of this calendar year.”
Jobs also attacked the current crop of 7-inch tablets which he said are going to be ‘DOA – dead on arrival.’ His point is that people think that a 7 inch screen is 70% as good as a 10-inch but reminds everyone it is only 45% as large in surface area. That’s important because it means that given that the screen takes up more than half the power of such devices, that an equal charge will last around 25% longer on those devices or better. Of course a battery of the same weight as an iPad could go on for a lot longer, but the very nature of the device is changed ‘ it is lighter, easier to store, but yes it is a little less easy to surf the internet with or type a treatise on.
Jobs said, ‘While one could increase the resolution of the display to make up some of the difference, it is meaningless unless your tablet also includes sandpaper, so that the user can sand down their fingers to around one-quarter of their present size. Seven-inch tablets are tweeners: too big to compete with a smartphone and too small to compete with the iPad.”
Here is he blatantly wrong. The iPad had a wonderful first quarter, but has barely eclipsed it in its second quarter, up to just 4 million devices from 3.3 million in its first quarter, and this is as its marketing opened out globally, against most forecasts of 5 million plus. We already type on tiny slider smartphones, we can sure as hell type on 7 inch screens.
But what Jobs must know is that Android can do both. It can offer these Tweeners with better battery life and easier stowage, AND it can offer the 10 inch tablet and the netbook as well. And the set top, and the smart phone ‘ everywhere Jobs looks he must see Android and because it is NOT a device, but an open source, free OS, it is bound to win. Just as Windows was not a device and the Mac always was.
Which is why he also tried to take aim at Android saying that it is fragmented, that the App Stores are fragmented and that their open platform, versus his closed platform, was a smokescreen. His belief is that ‘integrated’ is better for consumers. But each device is put together by one company, and they might do as good a job of integrating it as Apple, and while the chip makers, like Qualcomm, have found that it has taken time to bring to market a chip that can do everything the Apple A4 ARM chip can do, it’s only because it has so many masters and has to design it for building multiple devices types, which harness multiple OSs. The Qualcomm mantra right now is ‘integration,’ and it is shooting at a known design.
This puts us in mind of the major cycling races like the French Tour De France. Apple is perhaps the early leader on a cycling stage,who has pulled out a long lead, but it being chased by the ‘Peleton’ the bunch of chasers. When the sprints are over and the mountain climb begins, someone is bound to catch up. Perhaps all of them.
Which is why Apple right now is involved in all these IP wars. It is fighting on multiple fronts. It is trying to weigh its meager R&D effort against the collective efforts of the entire cellular industry. For every quarter where it has sales successes like this one, Apple builds up more and more bad will among those who it should have paid royalties to for designing cellular technology.
By the time that comes to a court, Apple could have achieved global Smart phone dominance, increasing the penalties to levels never before seen. Sure legal actions don’t turn markets, but they do take up senior management time and angst and eat into the collective self-belief of companies like Apple.
But all of this comes with a health warning. Apple may have turned the corner from a major market innovator to a blue chip, and while its growth may power on for a year or so, we can see that these ‘big’ steps forward will slow down, and become smaller steps. But incremental improvements in buying power, supply chain, the invasion of smaller, less profitable neighboring markets, will continue to see Apple revenues grow, albeit slower, and its consolidation of the few markets where it is dominant, and the geographical filling out of iPhone revenues, will mean that this stock has not yet completed its surges.
The value of Microsoft to the IT community ended in about 1997, peaking during its Anti-trust trial, and yet it retained the same kind of stock market valuation, just under $300 billion, for at least an entire decade past that point. Apple may not have quite the same grip on its customer base that Microsoft had, but its control of what is ‘cool’ and the delight of consumers with its designs, may give it another 3 to 4 years of continued upside, until its rivals completely block new paths to market growth.