Why Apple Investors Are Deservedly Worried

Apple announced the new iPhones recently.  And mostly, nobody cared.

Remember when users waited anxiously for new products from Apple?  Even the media became addicted to a new round of Apple products every few months.  Apple announcements seemed a sure-fire way to excite folks with new possibilities for getting things done in a fast changing world. 

But the new iPhones, and the underlying new iPhone software called iOS7, has almost nobody excited. 

Instead of the product launches speaking for themselves, the CEO (Tim Cook) and his top product development lieutenants (Jony Ive and Craig Federighi) have been making the media rounds at BloombergBusinessWeek and USAToday telling us that Apple is still a really innovative place.  Unfortunately, their words aren't that convincing.  Not nearly as convincing as former product launches.

CEO Cook is trying to convince us that Apple's big loss of market share should not be troubling. iPhone owners still use their smartphones more than Android owners, and that's all we should care about.  Unfortunately, Apple profits come from unit sales (and app sales) rather than minutes used.  So the chronic share loss is quite concerning. 

Especially since unit sales are now growing barely in single digits, and revenue growth quarter-over-quarter, which sailed through 2012 in the 50-75% range, have suddenly gone completely flat (less than 1% last quarter.)  And margins have plunged from nearly 50% to about 35% – more like 2009 (and briefly in 2010) than what investors had grown accustomed to during Apple's great value rise.  The numbers do not align with executive optimism.

For industry aficianados iOS7 is a big deal.  Forbes Haydn Shaughnessy does a great job of laying out why Apple will benefit from giving its ecosystem of suppliers a new operating system on which to build enhanced features and functionality.  Such product updates will keep many developers writing for the iOS devices, and keep the battle tight with Samsung and others using Google's Android OS while making it ever more difficult for Microsoft to gain Windows8 traction in mobile. 

And that is good for Apple.  It insures ongoing sales, and ongoing profits.  In the slog-through-the-tech-trench-warfare Apple is continuing to bring new guns to the battle, making sure it doesn't get blown up.

But that isn't why Apple became the most valuable publicly traded company in America. 

We became addicted to a company that brought us things which were great, even when we didn't know we wanted them – much less think we needed them.  We were happy with CDs and Walkmen until we discovered much smaller, lighter iPods and 99cent iTunes.  We were happy with our Blackberries until we learned the great benefits of apps, and all the things we could do with a simple smartphone.  We were happy working on laptops until we discovered smaller, lighter tablets could accomplish almost everything we couldn't do on our iPhone, while keeping us 24×7 connected to the cloud (that we didn't even know or care about before,) allowing us to leave the laptop at the office.

Now we hear about upgrades.  A better operating system (sort of sounds like Microsoft talking, to be honest.)  Great for hard core techies, but what do users care?  A better Siri; which we aren't yet sure we really like, or trust.  A new fingerprint reader which may be better security, but leaves us wondering if it will have Siri-like problems actually working.  New cheaper color cases – which don't matter at all unless you are trying to downgrade your product (sounds sort of like P&G trying to convince us that cheaper, less good "Basic" Bounty was an innovation.) 

More (upgrades) Better (voice interface, camera capability, security) and Cheaper (plastic cases) is not innovation.  It is defending and extending your past success.  There's nothing wrong with that, but it doesn't excite us.  And it doesn't make your brand something people can't live without.  And, while it keeps the battle for sales going, it doesn't grow your margin, or dramatically grow your sales (it has declining marginal returns, in fact.)

And it won't get your stock price from $450-$475/share back to $700.

We all know what we want from Apple.  We long for the days when the old CEO would have said "You like Google Glass?  Look at this…….  This will change the way you work forever!!" 

We've been waiting for an Apple TV that let's us bypass clunky remote controls, rapidly find favorite shows and helps us avoid unwanted ads and clutter.  But we've been getting a tease of Dick Tracy-esque smart watches. 

From the world's #1 tech brand (in market cap – and probably user opinion) we want something disruptive!  Something that changes the game on old companies we less than love like Comcast and DirecTV.  Something that helps us get rid of annoying problems like expensive and bad electric service, or routers in our basements and bedrooms, or navigation devices in our cars, or thumb drives hooked up to our flat screen TVs —- or doctor visits.  We want something Game Changing!

Apple's new CEO seems to be great at the Sustaining Innovation game.  And that pretty much assures Apple of at least a few more years of nicely profitable sales.  But it won't keep Apple on top of the tech, or market cap, heap.  For that Apple needs to bring the market something big.  We've waited 2 years, which is an eternity in tech and financial markets.  If something doesn't happen soon, Apple investors deserve to be worried, and wary.

Dell – Take the Money and Run! Innovation trumps execution.

Michael Dell has put together a hedge fund, one of his largest suppliers and some debt money to take his company, Dell, Inc. private.  There are large investors threatening to sue, claiming the price isn't high enough.  While they are wrangling, small investors should consider this privatization manna from heaven, take the new, higher price and run to invest elsewhere – thankful you're getting more than the company is worth.

In the 1990s everybody thought Dell was an incredible company.  With literally no innovation a young fellow built an enormously large, profitable company using other people's money, and technology.  Dell jumped into the PC business as it was born.  Suppliers were making the important bits, and looking for "partners" to build boxes.  Dell realized he could let other people invest in microprocessor, memory, disk drive, operating system and application software development.  All he had to do was put the pieces together. 

Dell was the rare example of a company that was built on nothing more than execution.  By marketing hard, selling hard, buying smart and building cheap Dell could produce a product for which demand was skyrocketing.  Every year brought out new advancements from suppliers Dell could package up and sell as the latest, greatest model.  All Dell had to do was stay focused on its "core" PC market, avoid distractions, and win at execution.  Heck, everyone was going to make money building and selling PCs.  How much you made boiled down to how hard you worked.  It wasn't about strategy or innovation – just execution. 

Dell's business worked for one simple reason.  Everybody wanted PCs.  More than one.  And everybody wanted bigger, more powerful PCs as they came available.  Market demand exploded as the PC became part of everything companies, and people, do.  As long as demand was growing, Dell was growing.  And with clever execution – primarily focused on speed (sell, build, deliver, get the cash before the supplier has to be paid) – Dell became a multi-billion dollar company, and its founder a billionaire with no college degree, and no claim to being a technology genius.

But, the market shifted.  As this column has pointed out many times, demand for PCs went flat – never to return to previous growth rates.  Users have moved to mobile devices such as smartphones and tablets, while corporate IT is transitioning from PC servers to cloud services.  iPad sales now nearly match all of Dell's sales.  Dell might well be the world's best PC maker, but when people don't want PCs that doesn't matter any more.

Which is why Dell's sales, and profits, began to fall several years ago.  And even though Michael Dell returned to run the company 6 years ago, the downward direction did not change.  At its "core" Dell has no ability to innovate, or create new products.  It is like HTC – merely a company that sells and assembles, with all of its "focus" on cost/price.  That's why Samsung became the leader in Android smartphones and tablets, and why Dell never launched a Chrome tablet.  Lacking any innovation capability, Dell relied on its suppliers to tell it what to build.  And its suppliers, notably Microsoft and Intel, entirely missed the shift to mobile.  Leaving Dell long on execution skills, but with nowhere to apply them.

Market watchers knew this. That's why  Dell's stock took a long ride from its lofty value on the rapids of growth to the recent distinctly low value as it slipped into the whirlpool of failure.

Now Dell has a trumped up story that it needs to go public in order to convert itself from a PC maker into an IT services company selling cloud and mobile capabilities to small and mid-sized businesses.  But Dell doesn't need to go private to do this, which alone makes the story ring hollow.  It's going private because doing so allows Michael Dell to recapitalize the company with mountains of debt, then use internal cash to buy out his stock before the company completely fails wiping out a big chunk of his remaining fortune.

If you think adding debt to Dell will save it from the market shift, just look at how well that strategy worked for fixing Tribune Corporation. A Sam Zell led LBO took over the company claiming he had plans for a new future, as advertisers shifted away from newspapers.  Bankruptcy came soon enough, employee pensions were wiped out, massive layoffs undertaken and 4 years of legal fighting followed to see if there was any plan that would keep the company afloat.  Debt never fixes a failing company, and Dell knows that.  Dell has no answer to changing market demand away from PCs.

Now the buzzards are circlingHP has been caught in a rush to destruction ever since CEO Fiorina decided to buy Compaq and gut the HP R&D in an effort to follow Dell's wild revenue ride.  Only massive cost cutting by the following CEO Hurd kept HP alive, wiping out any remnants of innovation.  Now HP has a dismal future.  But it hopes that as the PC market shrinks the elimination of one competitor, Dell, will give newest CEO Whitman more time to somehow find something HP can do besides follow Dell into bankruptcy court.

Watching as its execution-oriented ecosystem manufacturers are struggling, supplier Microsoft is pulling out its wallet to try and extend the timeline.  Plundering its $85B war chest, Microsoft keeps adding features, with acquisitions such as Skype, that consume cash while offering no returns – or even strong reasons for people to stop the transition to tablets. 

Additionally it keeps putting up money for companies that it hopes will build end-user products on its software, such as its $500M investment in Barnes & Noble's Nook and now putting $2B into Dell.  $85B is a lot of money, but how much more will Microsoft have to spend to keep HP alive – or money losing Acer – or Lenovo?  A billion here, a billion there and pretty soon it adds up to a lot of money!  Not counting losses in its own entertainmnet and on-line divisions.  The transition to mobile devices is permanent and Microsoft has arrived at the game incredibly late – and with products that simply cannot obtain better than mixed reviews.

The lesson to learn is that management, and investors, take a big risk when they focus on execution.  Without innovation, organizations become reliant on vendors who may, or may not, stay ahead of market transitions.  When an organization fails to be an innovator, someone who creates its own game changers, and instead tries to succeed by being the best at execution eventually market shifts will kill it.  It is not a question of if, but when.

Being the world's best PC maker is no better than being the world's best maker of white bread (Hostess) or the world's best maker of photographic film (Kodak) or the world's best 5 and dime retailer (Woolworth's) or the world's best manufacturer of bicycles (Schwinn) or cold rolled steel (Bethlehem Steel.)  Being able to execute – even execute really, really well – is not a long-term viable strategy.  Eventually, innovation will create market shifts that will kill you.