Staying on top is hard.
By Jared Dillian, Mauldin Economics:
Back when I was in business school, the PC manufacturers were go-go football stocks. Bull market, dude.
There was Dell, Hewlett-Packard, Compaq, and Gateway, which used to sell its computers in a Holstein cow-pattern box. Apple was making Macs but had a much smaller market share than it does today.
Business mags like Fortune and Forbes fawned over Michael Dell—how he had achieved this “mass customization” ideal in his manufacturing process.
You could pick out what kind of processor you wanted, what kind of hard drive, what kind of monitor, plus a few other options, and your tailor-made computer showed up at your doorstep in four to five days.
Eventually, though, commoditization replaced customization, PC margins went to zero, and that was the end of that.
Today, it’s hard to imagine the PC business any other way. Nobody puts a lot of thought into what kind of PC they are going to get. They’re all the same. Now people call their PC a “box” and the PC manufacturers “box-makers.” Like, there is no value added at all.
Dell went private. HP and Compaq merged, defensively. Gateway is gone. The idea that PCs were ever a growth business for anyone is crazy… right?
And yet we have these smartphones now, extremely powerful devices that are essentially miniature computers.
If You Own Apple Stock Today…
Innovation in the smartphone business has been very rapid, though it has slowed down in recent years, and the latest changes have been incremental. Apple’s 40% margins aren’t sustainable.
On the other hand, Apple has managed to keep its margins persistently high in every product line, from iPods to iMacs to iPhones—partly because of superior design, partly because of superior marketing. They have turned the phone into a status symbol.
If you own Apple stock, you are betting that:
- Apple will maintain or even increase its already huge market share in smartphones.
- Nobody will ever build a better mousetrap.
- The smartphone will resist the commoditization that has happened to pretty much every piece of technology.
Seems to me like there’s only one way for things to go right and lots of ways for things to go wrong.
I have no position and no particular axe to grind. While I don’t think the stock is especially overvalued, that doesn’t mean it can’t go down.
Besides, phones are different from computers. With the way wireless plans work in the US, people don’t bear the economic cost of the phone, at least not all at once. So the pricing pressure isn’t there like it was with PCs, which went from $2,000 to $600-$800 in the span of a few years.
But Apple has very much turned into a one-trick pony (60% of revenue comes from handsets) whose margins are perhaps not as bulletproof as we think. A $700 billion market cap rests on the existence of these margins.
The point here is, if you own this stock, directly or indirectly, to make you uncomfortable.
I probably wouldn’t short it, though. It’s hard to break an ankle jumping off a pizza box.
Clever Business Strategy—But Is It Clever Enough?
In any industry, there is usually only one Walmart. There isn’t room for two firms like that to survive.
In luxury goods, it’s different. There are 25-30 major brands of Swiss watches, and they each carve out a profitable existence.
Apple gets to have it both ways. They mass-produce a luxury good and make luxury company margins. That’s how they got a market cap of almost a trillion dollars. Very difficult to pull off. But they did it.
I have an iPhone. I have had the last few iterations, along with all the iOS updates. It is essentially the same phone. Let’s be truthful—Apple is not truly innovating at this point, just tinkering around the margins.
Staying on top is hard. But there is always the car!
By Jared Dillian. If you enjoyed Jared’s article, you can sign up for The 10th Man, a free weekly letter, at mauldineconomics.com. Follow Jared on Twitter @dailydirtnap. The article The 10th Man: Outside the Box was originally published at mauldineconomics.com.
Businesses are now catching the drift. Read… Chilling Thing Hershey Just Said About American Consumers
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
My wife and I do not own a cell phone, and most likely never will. We have money, and could buy new phones every month if we choose to do so. Just why would we buy a new phone every year? Can anyone tell me why? During the day, when I was still working, I would not be able to take calls. I was too busy working for my employers. They paid me to work, not take personal calls. People could call me at night. Now that I am retired, when I am outside and living my life I do not want to take phone calls. People can call me at night, leave a message on the answering machine, or send an email requesting me to phone them back. Why is someone’s elses time or their need to call me more important than what I am doing in the here and now? If a family crisis is unfolding, and they have, we are pro-actively in contact before any actual emergency. We don’t even need a phone for that. Car breaking down? I drive a 30 year old pickup and it doesn’t break down, why would our 2009 Toyota break down where I just need a phone to call for help? Not too likely.
The last thing I want to hear during the day is a phone, then have to pick it up and look at the display, then decide if I should take the call right then and there. Meanwhile, my dinner companion….my life companion, looks on knowing right then and there my phone call is more important than her.
I have seen couples having dinner, each on their seperate phones. I have seen Dads having a donut with their child, he on his phone and the child on a play phone playing some inane game. I have seen doofus idiots tryiung to bag their groceries while talking on a phone. It’s bullshit.
As someone who is between Gen X and Gen Y, I have watched the cell phone morph from a communication tool for emergency/necessity use only, into a zombie creating device of utmost importance to people. I don’t know how many times I have seen accidents caused by this focused attention on a communication device. I work in the IT field and of course have to embrace technology as part of the job, but at some point we have to ask ourselves if the very tools designed to make us more efficient, are in fact making our lives more complicated and less meaningful.
I do think the US and probably the globe are saturated now with iPhones. Seems like all unit growth is now coming from winning market share from Samsung and from cannabilizing their own iPads. About why own an iphone? That seems like a very odd question to me. I use the phone for email, for internet, for phone calls particularly FaceTime, for gps, for texting, etc. I wouldn’t know what to do without my iPhone. I monitor and trade stocks on it and read news, particularly when I’m commuting to and from work in my car and waiting in line somewhere or if wifi isn’t working somewhere. I also talk to my wife and kids on FaceTime often so I can see them. I also use viber for free international calling. For communicating with friends, I have groups of friends set up in little text chat rooms, so communication is convenient and easy. Guys, in particular, don’t want to talk to each over the phone-prefer texting. I also sometimes listen to music and use the gps on my iPhone. It’s an awesome device, though I do think margins are going to go way down and I don’t like the stock… Their earnings could easily be cut in half in two to three years imo.
I’m with you Paulo. My wife and I have cell phones for emergencies on the road. They are never turned on unless we need to use them. I too dislike being like a monkey on a leash to a phone. Had enough of that at work before retirement, as did the wife.
Watching those addicted to their “devices” is a hoot. Before I retired, my office was located on a state university campus. One day, I was walking across campus to my office and came to one of those points where five sidewalks cross. Coincidentally, three people, two students and an instructor, and myself met at confluence of sidewalks. The three I met were all face down in their phones, clueless to the world around them. I couldn’t help myself. As we met, I was in the middle of the three and I said what I was thinking. As if it was a greeting, I simply said “A$$holes. Not one of them noticed or even looked away from their phones. Addiction? Oh yes!! I rest my case.
Scott Galloway says it best for branding and Apple in particular:
http://www.thegray-market.com/blog/apple-the-art-market
or
https://www.youtube.com/watch?v=XCvwCcEP74Q
quotes:
“Rich people are the most boring people in the world. They smell, look, and feel alike. They all fly British Airways, wear Hermès, and party in St. Barths… Luxury brands are able to go global faster because rich people aspire to the same things.”
and the winner (see the video for the context):
“As you move down the torso, the margins get better and the business gets better. Luxury is in the business of propagation.”
You are wrong about one thing here. Most of the Swiss watch brands (Longines, Omega, SWATCH, Rado, Tissot) are owned by The Swatch Group, and Swatch doesn’t make its money selling watches, it makes most of its money laundering money for the Swiss banks. Swatch has a subsidiary called Swiss Timing, which doesn’t sell watches, it provides sports timing & results services for the Olympics and for many Swiss-based sport federations (FIS, FINA, UCI, FEI). Swiss Timing was caught laundering tens of millions of dollars through the 2010 Commonwealth Games in India, shining light on exactly how Swatch Group actually makes its money. Swiss Timing washes illicit cash through various World-level ski racing, swimming, equestrian, and bike racing events & national federations around the world and it eventually comes back “clean” into the legitimate banking system.
There are currently arrest warrants outstanding for three executives of Swiss Timing, but the Swiss police won’t arrest the three criminals in question – just as they wouldn’t arrest Marc Rich, or Roman Polanski, etc.
It’s all in the public record – just do a search on the terms “Swiss Timing”, “fraud”, “corruption” “Commonwealth Games”.
Wow. What an obvious Apple bashing slant. A very popular position especially now that doomsayers have been proven wrong… at least for the moment anyway. Your attempt at impartiality failed miserably.
Typical pointless drivel. Yes Apple is awesome right now, but what happens when they can’t be awesome anymore? What happens when what’s working for them now stops working for them in the future? The stock price will tank and I would have been right in my assessment. Bravo! My hero! Tell it like it is Wolf.
Android phones are getting better and cheaper everyday, yet the iPhone keeps gaining more market share despite the higher price. They simply make quality products that people love. Only when that dynamic starts to wane will I turn bearish.
You and everyone else can’t get around the fact that Apple is still around and stronger than ever. It’s not supposed to be that way. They should have imploded by now. Maybe they will one day but there are certainly no signs of weakness at the moment.
I love the miserable curmudgeons in the comments section weighing in as well. Always a treat.
It’s called commoditization. Dell gained market share too. All tech gadgets, sooner or later, become commodities. Desktops did. The iPod did (remember?) That’s the theme of the article. Smartphones are getting closer. And when that happens, the big-fat margins are beginning to shrink. Apple will always try to get more for its products, but so did IBM with desktops. Read the article again and see what the author (Jared) is telling you.
Actually, the iPod never really became a commodity. Apple killed it themselves with the iPhone. The PC makers all tried to get into the MP3 game and all failed (even Microsoft tried and failed). I use both Android and Apple for work and am impartial.
That’s right Michael. Most companies would never introduce a product that would cannibalize a top seller like the iPod. The iPad cut into their laptop sales and the Plus size iPhone cut into iPad sales. It goes on and on. Regardless they keep growing. Margins as well. Why? Superior products people love.
I love your blog Wolf. I read it daily. I apologize for going over the top with my critique. I guess I’ve just read too many articles reinforcing the Apple downfall MYTH in light of another record breaking quarter.
However that doesn’t justify being impolite and immature about it.
Sorry Wolf. Have a good day bud.
The thing Apple (actually Jobs) does (did) far better than anyone else EVER is marketing. Months before the introduction of a new product, all media outlets start covering it in glowing terms, free of charge, creating enthusiasm around the globe. This is an impossible feat for any other company. Their ads are superb too. I even remember the iPod ad on billboards – the only billboard ad ever that I remember. MP3 players had been around for years. But Jobs turned tech gadgets into the ultimate expression of cool. I think that was his biggest genius (“biggest” because he was a genius in many aspects).
I have it on good authority, an ex-apple employee, that since Steve Jobs demise his succesors have run out of ideas, having implemented almost all of them. Now, instead of taking the lead by changing direction of the market, Apple waits for someone else to go first and then tinkers with their ideas.
Until this year I had an iphone but a popup re signing into icloud kept popping up every few seconds regardless. Unable to find the cure, said the mobile phone shop person, so I took the bull by the horns and got a samsung galaxy s6. Much better, it connects a telephone call at first attempt, the iphone needed 3 goes, and is for my needs more efficient.
Otherwise I ditched my pc long ago and use iMacs, we have 3 and i have recently got another. I know i pay a premium gor design but the Apple developer community comes over as a friendlier bunch than the PC world and that too is worth paying for.
Apple stock price is I reckon inflated by stock availability shortage. Every so often a shareholder cashes in, whereupon the stock price falls whereupon the media suggests the end of the road for Apple. Outsiders seem to forget that the stock market is a money-making machine for traders.
Let’s focus on the financial part of Apple.
AAPL is most likely overvalued, not because of any fault on part of the company but because every other stock is. Look at Chevron (CVX): bloodied by the oil slump, freshy announced another round of layoffs and in a single month it has gone from $78 to $90, an over 15% gain built on absolutely nothing but euphoria.
Trying to make sense of stock values these days is a fool’s errand.
AAPL stocks are held in enormous quantities by both the largest private hedge funds and some of the most active sovereign funds (Norway’s SBU and Switzerland’s BNS, the local central bank cum hedge fund), not to mentiond untold numbers of retail investors worldwide. Rarely, if ever, has a single stock been so important.
Leaving aside the company’s fundamentals, this alone ensures unless something truly catastrophic happens a sudden massive dump is highly unlikely in the near future. Investors are hungry for AAPL and any dump would quickly find buyers ready and willing to take advantage of the momentary low price.
AAPL hence moves perfectly in sync with stock markets. if it goes down, like it did earlier this year, is because everybody else is going down.
The only problem I see at the moment with Apple as a company is their margins: 40% is not sustainable, at least not for long.
Smartphones will fall prey to commodization sooner than anybody would like: I read somewhere that over 60% of the world’s population now owns a smartphone and these items are extremely widespread even in very poor Third World countries.
Mainland Chinese companies are jumping into the fray with highly competitive products, ironically helped Android’s smashing success as the sole true rival to Apple’s iOS. When Chinese companies enter the fray… you know commodization isn’t too far behind.
Apple’s true challenge is to keep those margins at very least around 20% mid-term and to make the decline as even as possible to avoid setting off alarms among the most cautious hedge fund managers.
Cell phones and tablets are rapidly becoming commodities. It took the PC industry 20 years for the commoditization effect to take effect and now a PC that is sold for $3000 in 1984 dollars sells for next to nothing today. With smartphone and tablets, it’s happening in less than half that time.
My IPhone 6 is a $700 phone (I payed much less because of the 2 year contract with the carrier). I know I can find a far a comparible if not superior phone for less from numerous companies that produce smartphone.
Yes Apple products are status symbols, but better design, software and reliability, I thing not. A status symbol works well for cars, but not for gadgets, and if that is all that is holding up the companies stock price, then Apple (like Dell before it) will fall in time.
As an experienced product designer I’m not sure I agree with this commoditisation argument. The article makes the point that there are a number of high end watch manufacturers who are profitable. I’d argue that watches are one of the maturest technologies around, yet there are clearly specialist players who can extract very high prices & premiums for their products. Yes Jobs was a genius, but his skill (as Wolf argues) was primarily in marketing, and that is the key here – Apple, unlike most tech companies, focusses on aspects of design which create an emotional attachment with their customer base. A second consideration (again good marketing) is that they make products which work simply/well either as standalone entities or in combination with their other products. That ease of use and perceived value add (of things which look/feel better than the opposition) is at the heart of Apple’s commercial strength. Apple isn’t really much different to other tech company – it just creates products which the masses perceive to be worth paying more for.
As a tech designer I would rarely buy Apple products – I buy the things which I think provide the solution I need at the cheapest possible price, and that is rarely Apple. However if friends ask for advice on tech purchases I always include Apple as being worth consideration where ease of use and perceived quality/service are important. A very large proportion of my non-tech friends end up going with Apple for those specific reasons, and those people then usually keep buying Apple thereafter because experiencing those characteristics creates tremendous brand loyalty.
So whilst I would agree that increasing commoditisation in the mobile phone space might impact Apple’s top line in this market over time, I suspect they have a more defensible position on margins because they are a high volume “luxuries” company rather than just a tech company. They will be highly profitable until either something tarnishes the emotional attachment people feel to the brand, or the economic situation becomes so tight for their customer base that people are no longer prepared to pay those premiums.
Keep up the good work Wolf. Really appreciate all the pragmatic/informed content here.
people who underestimate the strength of Apple product line and their stock have missed out on great returns over the last 8 years.
Bash the stock, the phones, the consumers and their Genius Bar all you want.. it’s about the largest company in the world. with a decent P/E and record for steady growth.