Apple at the Crossroads
by Mark W. Hibben
Another Record Quarter
Apple once again blew past the financial analysts, reporting record revenue of US$26.74 B and profit of US$6B, at the Apple Financial Results conference call this afternoon. Apple's stock price, which had suffered with the news of Steve Jobs latest health woes, recovered nicely in after-hours trading. Exceeding analysts' expectations has become the norm for Apple, and one has to wonder why the financial analysts can't correct for this, as the blogger community already has. Nevertheless, the tone of the analysts at the call was decidedly more upbeat than last time, as if they're finally grasping the fact that Apple's earning performance is not merely a fluke. With Apple's stock trading at a price to earnings ratio above the Nasdaq norm, the investment community seems to be getting this as well.
Clouds on the Horizon
So why am I vaguely uncomfortable? A number of trends should concern the Apple investor. Although the iPhone and iPad sales have been impressive, and Tim Cook reported that Apple has now sold a total of 167 million iOS devices, the growth of Android has been explosive and Android already has overtaken iOS in worldwide Mobile OS market share according to Gartner research. At the call, there was no detectable sense of urgency about this on the part of Apple management. It may be just a front, however. When asked about the “competitive landscape” for the iPad, Tim Cook ticked off a breakdown of three groups of competitors, all of whom were non-competitive in his view. The first group was the Windows based tablets, which were characterized as heavy with short battery life and requiring a stylus. Obviously not really comparable in features to the iPad, but for many, still a worthwhile alternative. The second group was the Android based tablets, which Cook characterized as “scaled-up smart phones” and “bizarre products”, as if no one in their right minds would want one. Yet, one could certainly characterize the iPad as a “scaled up” iPhone without disparagement, since it uses the identical processor and operating system.
The third group was what Cook called “next-gen” Android OS tablets that were “vapor ware” in his view, since they’re not shipping yet. Finally, Cook said that they were “very confident about entering a fight with anyone”, which was probably the most candid admission we’ll ever get from Apple that they’re about to enter a fight. I’m certain that everyone in Apple management realize that “Honeycomb” Android tablets running dual core Cortex-A9 ARM processors will be very competitive. Given the rapidity with which Android OS has overtaken iPhone OS in the smartphone marketplace, it doesn’t take much imagination to conceive of the same thing happening to iPad.
Another disturbing trend is the on-going constrained supply of iPhones, which has arguably contributed to Apple not being able to keep up with the Android population explosion. Needless to say, there were questions from every analyst about the supply constraint effect on iPhone sales and the potential effect on Verizon iPhone sales. Apple execs were very tight lipped about this. They wouldn’t speculate about what iPhone sales could have been without the supply constraint, or when the shortage would be alleviated. The analysts’ leading questions about the Verizon iPhone were clearly meant to imply that the situation will only get worse once the Verizon iPhone goes on sale. Cook would only say that they’re doing everything possible to supply their customers, and hinted that there had been significant cash outlays of pre-payments designed to ensure component supplies as well as capital equipment purchases by suppliers. Since Cook had also taken pains to point out that Apple had specifically avoided investing in a “fabrication capability”, he seemed to be saying that Apple wasn’t above helping to build up key suppliers’ fabrication capability.
Supply chain constraints seem to be the crucial area of disadvantage of the Apple model compared to the Google (Microsoft) model. Google can recruit a large supplier base without having to commit to any purchases. Google supplies the OS, but it's up to the manufacturer to sell the phone. Apple must carefully cultivate the supplier base, putting suppliers under contract to deliver parts or assemblies. Since the last thing any company would want is to over commit to purchases of parts or assemblies and then discover that these parts can't be sold because of a miscalculation of demand, the supply chain management process is necessarily cautious and the result is a tendency to underestimate demand.
Apple's supplier capability is growing rapidly to be sure, but one has to wonder whether it can ever keep up with the Android OS ecosystem.
Keeping up with iPhone demand while avoiding an “overshoot” effect in which manufacturing capability over-expands is clearly one of the greatest challenges facing Apple management. Apple’s growth in the Asia-Pacific region has been explosive, with Cook reporting a 175% year over year revenue growth. Now that Apple has a CDMA version of the iPhone, it’s also possible for Apple to add more carriers abroad, as one analyst suggested. These opportunities for growth are only wasted if Apple can’t solve its supply constraint problems for the iPhone.
In light of the iPhone supply problem, Apple's cash position has gone from annoying to ridiculous. According to Peter Oppenheimer, Apple CFO, Apple's cash position grew to US$59.7B, and he actually seemed proud of this. Well, they all do. Yes, it's a big pile of money, and the last thing they should be doing with it is using it to lounge around on. Apple should be using this money to grow intelligently, by acquisition and organically, yet there's no sign of this. The pile just keeps getting bigger.
Thinking the Unthinkable
Jobs' most recent health-driven leave of absence has forced me to think about the post-Jobs Apple. There will be life after Jobs, to be sure, and it can be a good life at Apple, if the necessary plans are put into place soon, if not immediately. Apple badly needs an heir-apparent. Tim Cook? He makes a great second in command, but he lacks the unique technological vision that Jobs has. Jobs has always been a futurist, even when he was wrong, as when he endowed Next computers with (then new) re-writable optical drives but no hard drives. The vicissitudes of Jobs' life have tempered his futurism with practicality, giving him an almost uncanny ability to discern and direct winning products. Although the latest earnings report has become an occasion to extol the virtues of the Apple management team, I don't really see anyone in it to fill Jobs' shoes. Yet.