Luck or Vision
Following Apple's earnings release earlier this week, there seems to be a rather twisted and intellectually dishonest argument gaining steam that Apple is becoming a risker company simply because the iPhone is so successful. Bernstein analyst Toni Sacconaghi did a great job at summing up this prevailing attitude with the following quote given to The New York Times:
“There’s always the risk of another paradigm shift. Who knows what that might be, but Apple is living and dying by the iPhone. It’s a great franchise until it isn’t.”
According to Sacconaghi, it sure sounds like Apple is lucky that the iPhone has been so successful and Tim Cook should be concerned that his luck can run out overnight. Another paradigm shift may come along and make the iPhone irrelevant, with only Apple feeling the brunt of this shift. Sacconaghi has a $135 target price and Outperform rating for Apple, so his quote isn't so much a bad stock call turning into sour grapes. Instead, his comment symbolizes the confusion that exists in the marketplace concerning Apple.
Has Apple's successes over the past 15 years been due to sheer luck or effective vision? One way of answering this question is to analyze a company that was actually lucky: Blackberry. The company was able to take initial successes in mobile technology and turn it into a $83 billion market cap as little competition and unwavering enterprise support drove years of strong growth and success. However, a quick look at the product portfolio would tell a different story. Compare a Blackberry phone from 2004 with one from 2010 to see what luck looks like. Even after Apple introduced the iPhone and then eventually the App Store, Blackberry shrugged it off, showing little understanding of its market and customer base. Missing a feature here and there can be costly, but manageable. However, missing an entire era can be lethal. Blackberry's luck had run out.
Meanwhile, compare the iPhone 6 and 6 Plus to the original iPhone. Apple's focus is on making great products with often the only limiting factors being of a technological nature. Every other year Apple has focused on not only changing the iPhone's form factor for the sake of change, but to improve the user experience. As screens have become bigger, battery life has gotten better, and devices have gotten thinner. Apple has then used the "S" cycle off years to introduce updated components to the iPhone, and in the case of iPhone 5S, new features like TouchID.
Jony Ive, Apple SVP of design, back in October at a Vanity Fair event, discussed how Apple had iPhone prototypes that included large screens in an effort to see what would make the best product. In the end, design challenges pushed off large screens for a few years. Today Apple is shipping iPhones with larger screens and Apple continues to see 15-20% of iPhone buyers come from other smartphone platforms. Just as an Apple critic can claim Apple may have dragged their feet a year or two too long to introduce larger iPhones in response to competitors, the discussion can be quickly turned around to reflect how Apple added a fingerprint sensor to iPhone in 2013, a feature that was considered a gimmick up to that point. Apple has also been very successful in understanding its next marginal iPhone buyer and not shipping phones with features that over serve the market. If this type of forward-thinking is simply luck packaged in a pretty box, then most of Apple's peers wish Tim Cook would share some of that luck.
Despite reporting a record quarter, Apple still has risk factors. Apple includes these risk factors in its 10-Q and 10-K filings. One risk factor in its 10-Q filed earlier this week seemed to apply to this luck versus vision discussion:
“The Company’s ability to compete successfully depends heavily on its ability to ensure a continuing and timely introduction of innovative new products and technologies to the marketplace. The Company believes it is unique in that it designs and develops nearly the entire solution for its products, including the hardware, operating system, numerous software applications and related services. As a result, the Company must make significant investments in R&D. The Company currently holds a significant number of patents and copyrights and has registered and/or has applied to register numerous patents, trademarks and service marks. In contrast, many of the Company’s competitors seek to compete primarily through aggressive pricing and very low cost structures, and emulating the Company’s products and infringing on its intellectual property. If the Company is unable to continue to develop and sell innovative new products with attractive margins or if competitors infringe on the Company’s intellectual property, the Company’s ability to maintain a competitive advantage could be adversely affected. ”
Management is pretty clear on why it thinks it has been successful. Not only does Apple simply ship new products every year, but Apple:
- designs hardware
- develops operating systems
- creates numerous software applications
- introduces new services
- invests in R&D
- registers for patents and copyrights
Apple's biggest risk isn't that the iPhone makes up 60% of revenue, but rather failing in any of the preceding bullet points. Claiming that Apple is too dependent on iPhone implies that Apple got to where it is by luck. I don't think that is genuine criticism. Instead, Apple got to where it is today by executing on its vision. Failure to stand by that vision represents Apple's biggest risk factor.