Apple’s stock is on a tear. After languishing for well over a year, it is back to record high levels. Once again Apple is the most valuable publicly traded company in America, with a market capitalization exceeding $700 billion. And pretty overwhelmingly, analysts are calling for Apple’s value to continue rising.
But today’s Apple, and the Apple emerging for the future, is absolutely not the Apple which brought investors to this dance. That Apple was all about innovation. That Apple identified big trends – specifically mobile – then created products that turned the trend into enormous markets. The old Apple knew that to create those new markets required an intense devotion to product development, bringing new capabilities to products that opened entirely new markets where needs were previously unmet, and making customers into devotees with really good quality and customer service.
That Apple was built by Steve Jobs. Today’s Apple has been remade by Tim Cook, and it is an entirely different company.
Today’s Apple – the one today’s analysts love – is all about making and selling more iPhones. And treating those iPhone users as a “loyal base” to which they can sell all kinds of apps/services. Today’s Apple is about using the company’s storied position, and brand leadership, to milk more money out of customers that own their devices, and expanding into adjacent markets where the installed base can continue growing.
UBS likes Apple because they think the services business is undervalued. After noting that it today would stand alone as a Fortune 100 company, they expect those services to double in four years. Bernstein notes services today represents 11% of revenue, and should grow at 22% per year. Meanwhile they expect the installed base of iPhones to expand by 27% – largely due to offshore sales – adding further to services growth.
Analysts further like Apple’s likely expansion into India – a previously almost untapped market. CEO Cook has led negotiations to have Foxxcon and Wistron, the current Chinese-based manufacturers, open plants in India for domestic production of iPhones. This expansion into a new geographic market is anticipated to produce tremendous iPhone sales growth. Do you remember when, just before filing for bankruptcy, Krispy Kreme was going to keep up its valuation by expanding into China?
Of course, with so many millions of devices, it is expected that the apps and services to be deployed on those devices will continue growing. Likely exponentially. The iOS developer community has long been one of Apple’s great strengths. Developers like how quickly they can deploy new apps and services to the market via Apple’s sales infrastructure. And with companies the size of IBM dedicated to building enterprise apps for iOS the story heard over and again is about expanding the installed base, then selling the add-ons.
Gee, sounds a lot like the old “razors lead to razor blade sales” strategy – business innovation circa 1966.
Overall, doesn’t this sound a lot like Microsoft? Bill Gates founded a company that revolutionized computing with low-cost software on low-cast hardware that did just about anything you would want. Windows made life easy. Microsoft gave users office automation, databases and all the basic work tools. And when the internet came along Microsoft connected everyone with Internet Explorer – for free! Microsoft created a platform with Windows upon which hordes of developers could build special applications for dedicated markets.
Once this market was created, and pretty much monopolized by Microsoft CEO Gates turned the reigns over to CEO Steve Ballmer. And Mr. Ballmer maximized these advantages. He invested constantly in developing updates to Windows and Office which would continue to insure Microsoft’s market share against emerging competitors like Unix and Linux. The money was so good that over a decade money was poured into gaming, even though that business lost more money than it made in revenue – but who cared? There were occasional investments in products like tablets, hand-helds and phones, but these were merely attractions around the main show. These products came and went and, again, nobody really cared.
Ballmer optimized the gains from Microsoft’s installed base. And a lot – a lot – of money was made doing this. nvestors appreciated the years of ongoing profits, dividends – and even occasional special dividends – as the money poured in. Microsoft was unstoppable in personal computing. The only thing that slowed Microsoft down was the market shift to mobile, which caused the PC market to collapse as unit sales have declined for six straight years (PC sales in 2016 barely managed levels of 2006). But, for a goodly while, it was a great ride!
Today all one hears about at Apple is growing the installed base. Maximizing sales of iPhones. And then selling everyone services. Oh yeah, the Apple Watch came out. Sort of flopped. Nobody really seemed to care much. Not nearly as much as they cared about 2 quarters of sales declines in iPhones. And whatever happened to AppleTV? ApplePay? iBeacons? Beats? Weren’t those supposed to be breakthrough innovations to create new markets? Oh well, nobody seems to much care about those things any longer. Attractions around the main event – iPhones!
So now analysts today aren’t put in the mode of evaluating breakthrough innovations and trying to guess the size of brand new, never before measured markets. That was hard. Now they can be far more predictable forecasting smartphone sales and services revenue, with simulations up and down. And that means they can focus on cash flow. After all, Apple makes more cash than it makes profit! Apple has a $246 billion cash hoard. Most people think Berkshire Hathaway, led by famed investor Warren Buffett, spent $6.6 billion on Apple stock in 2016 because Berkshire sees Apple as a cash generation machine – sort of like a railroad! And if those meetings between CEO Cook and President Trump can yield a tax change allowing repatriation at a low rate then all that cash could lead to a big one time dividend!
And, most likely, the stock will go up. Most likely, a lot. Because for at least a while Apple’s iPhone business is going to be pretty good. And the services business is going to grow. It will be a lot like Microsoft – at least until mobile changed the business. Or, maybe like Xerox giving away copiers to obtain toner sales – until desktop publishing and email cratered the need for copiers and large printers. Or, going all the way back into the 1950s and 60s, when Multigraphics and AB Dick practically gave away small printers to get the ink and plate sales – until xerography crushed that business. Of course you couldn’t go wrong investing in Sears for years, because they had the store locations, they had the brands (Kenmore, Craftsman, et.al.,) they had the credit card services – until Wal-Mart and Amazon changed that game.
You see, that’s the problem with all of these sort of “milk the base” businesses. As the focus shifts to grow the base and add-on sales the company loses sight of customer needs. Innovation declines, then evaporates as everything is poured into maximizing returns from the “core” business. Optimization leads to a focus on costs, and price reductions. Arrogance, based on market leadership, emerges and customer service starts to wane. Quality falters, but is not considered as important because sales are so large.
These changes take time, and the business looks really good as profits and cash flow continue, so it is easy to overlook these cultural and organizational changes, and their potential negative impact. Many applaud cost reductions – remember the glee with which analysts bragged about the cost savings when Dell moved its customer service to India some 20 years ago?
Today we’re hearing more stories about long-term Apple customers who aren’t as happy as they once were.
Genius bar experiences aren’t always great. In a telling AdAge column one long-time Apple user discusses how he had two iPhones fail, and Apple could not replace them leaving the customer with no phone for two weeks – demonstrating a lack of planning for product failures and a lack of concern for customer service. And the same issues were apparent when his corporate Macbook Pro failed. This same corporate customer bemoans design changes that have led to incompatible dongles and jacks, making interoperability problematic even within the Apple line.
Meanwhile, over the last four years Apple has spent lavishly on a new corporate headquarters befitting the country’s most valuable publicly traded company. And Apple leaders have been obsessive about making sure this building is built right! Which sounds well and good, except this was a company that once put customers – and unearthing their hidden needs, wants and wishes – first. Now, a lot of attention is looking inward. Looking at how they are spending all that money from milking the installed base. Putting some of the best managers on building the building – rather than creating new markets.
Who was that retailer that was so successful that it built what was, at the time, the world’s tallest building? Oh yeah, that was Sears.
Markets always shift. Change happens. Today it happens faster than ever in history. And nowhere does change happen faster than in technology and consumer electronics. CEO Cook is leading like CEO Ballmer. He is maximizing the value, and profitability, of the Apple’s core product – the iPhone. And analysts love it. It would be wise to disavow yourself of any thoughts that Apple will be the innovative market creating Jobs/Ives organization it once was.
How long will this be a winning strategy? Your answer to that should determine how long you would like to be an Apple investor. Because some day something new will come along.