Industry Analysis for Apple

Apple

Industry Analysis

Apple competes in the consumer electronics industry, predominantly on the hardware side, but also on the software side. The most significant product that the company makes is the iPhone, which accounts for $155 billion in revenue out of a total revenue of $233 billion. The Mac computers generate $25 billion, the iPad $23 billion, services $19 billion and "other" $10 billion. Most of other consists of software and peripheral products, along with any residual iPod sales that might still exist (Apple Co. 2015 Form 10-K). This breakdown highlights that Apple is primarily a hardware company, though its hardware is embedded with the company's own software. Of these businesses the iPhone is a major growth business, having increased 52% over the previous year on the basis of the iPhone 5 release. The iPad is a declining business, having dropped 23%, while other businesses saw more modest increases. "Other products" increased 20% in FY 2015, but that merely restored revenues following a 17% decrease in 2014 (Apple Co. 2015 Form 10-K).

Apple's business is global in nature. The company operates many of its own retail channels, including its own stores and online retail site. In 2014, Apple was the second-biggest online retailer in the world, with online revenues of $20.6 billion. While this is nowhere near the level of market leader Amazon, it is higher than any other company, and most of those companies sell a very broad range of products, in multiple countries (Statista, 2014). The company earned $93 billion in revenue in the Americas, $58 billion in Greater China, $50 billion in Europe, $15 billion in Japan and $15 billion in the rest of Asia-Pacific (Apple 2015 Form 10-K). Sales growth in the Americas was strong at 17%, and solid in Europe at 14%. The largest growth region, however, was Greater China at 84%. Greater China consists of the PRC, Taiwan, Hong Kong and Macau. The rest of Asia Pacific is also a strong growth market at 34%. This market consists of South Korea, Australia, New Zealand and the Southeast Asian nations. Other markets such as the Middle East and Africa are structured under Europe.

Working with this industry definition, there are a few different tools to understand the profitability and desirability of this industry. As a general rule, this is a high growth industry with large profit margins, both characteristics that Apple has been able to leverage significantly. A Five Forces analysis highlights that this is generally a positive industry in which to operate, and that Apple has a powerful position that accentuates these benefits. The five forces that determine profitability in an industry are the bargaining power of buyers, the bargaining power of suppliers, the threat of new entrants, the threat of substitutes and the intensity of rivalry among existing competitors (QuickMBA, 2010).

The bargaining power of buyers is low. There are several factors that influence this. First, there are few players at the high end of the smartphone market, but most buyers in the industrialized nations prefer to buy at the high end. Essentially, the high end is a duopoly between Apple and Samsung. Consumers have relatively little knowledge about the costs of producing smartphones and other electronics, and they lack price sensitivity. They generally are willing to pay the going rate for these products, and this gives companies at the high end the advantage. Consumers are more sensitive to features, so feature-rich products reduce price sensitivity. This allows the high end products to carry high margins.

The bargaining power of suppliers is low. In general, suppliers in this industry offer commodity goods, so companies like Apple can shop around for the best deal. Furthermore, there are more suppliers in the industry than there are major vendors like Apple. This is important, because Apple's economies of scale are critical to the success of its suppliers. While Apple can readily change suppliers, the suppliers will never find another Apple. This gives Apple significant bargaining power over suppliers.

The threat of new entrants remains fairly high. The high availability of OEM parts allows many new companies to enter this business. These include established players that once had a bigger role in the industry such as Nokia or Motorola, operating system producers like Google or Microsoft, and it also includes low cost upstarts, mostly from China, who enter via the low end of the market and build share from there. An example of the latter would be Xiaomi, which specializes in lower-end phones for the Chinese market. Xiaomi had a 1% share of the global market in 2012, and by 2015 had built up a 5.6%. Huawei is another low-cost Chinese manufacturer that has doubled its share between 2012-2015 (IDC, 2015). Most of these companies build their share at the expense of the high end market, as the difference between high end phones and the mid-range models begins to shrink. So the threat of new entrants is high, and will continue to be as long as the gap between the best phones and the mediocre ones continues to shrink.

The threat of substitutes is fairly low. In the space of just a few years, smartphones have become an essential item for most consumers, especially ones in the West. The reason for this is that they are feature-rich, replacing the need for several different items. It would be difficult to conceive of a device that replaced this sort of multi-functionality. There was risk, for a short time, that tablets might take market share from smartphones, but a move to larger smartphones has essentially parried this assault. Moreover, Apple was the leader in tablets anyway, and would have merely cannibalized itself. Thus, there is very little risk, as smartphones have proven the more popular version of mobile technology and Apple tends to be involved in any potential substitutes. There is no disruptive technology on the horizon.

The intensity of rivalry among firms is fairly intense. This rivalry occurs both with handsets and with operating systems. At the O/S level, Apple competes primarily with Google and a little bit with Microsoft. At the handset level, Samsung is the market leader, and the other major market share holder s do not compete in the high end segment. Apple basically operates in two duopolies simultaneously in this business. In a duopoly, the intensity of rivalry is high. Competitors often make moves based on what each other is doing. Usually, this results in prices falling, but this industry is unique is that features are the main draw and there is relatively little price elasticity of demand. This means that there are healthy profits for both firms, and only at the lower end where consumers are price sensitive does the intensity of rivalry manifest in tighter margins. For Apple and Samsung, the manifestation of intensity of rivalry is more in the race for innovation. This results in both companies spending a lot of money on R&D, though nowhere near as much as they are earning in profits.

All told, this is a profitable industry in which to operate. Apple holds substantial bargaining power over buyers and suppliers, the threat of substitutes is low. The threat of new entrants is high, but they usually enter at the low end and have trouble catching up to Apple in terms of their technology. This also insulates Apple from dangerous rivalries. As long as Apple continues to be the technology leader, or matched with Samsung and Google in that regard, then Apple will continue to enjoy a high profit margin on its products.

PEST analysis

A PEST analysis examines the external market. The political environment is generally favorable, though Apple has occasionally seen problems with foreign governments. There have been lawsuits between Apple and Samsung over patents, and Apple has faced some minor political scrutiny over labor practices at its contractors. In general, however, Apple has not faced significant political impediments to its business. The economic environment does not appear to be relevant for Apple. During the last recession, Apple was in the early stages of marketing the iPhone, and the product sold at a tremendous pace despite the economic downturn. Apple has proven to be resilient to economic slowdowns as its products are popular and many of its customers do better in poor economic conditions than non-customers. Apple's beta of 0.98 indicates that the company's stock moves roughly in line with the stock markets, but the stock markets have been somewhat disconnected from U.S. economic growth for several years (MSN Moneycentral, 2016).

The social environment is strongly positive for Apple. The company has a favorable public image, and its products are viewed as innovation leaders. There are millions of Apple fans who basically discount the possibility of buying products from any other company. While Apple has come under fire for labor practices at its subcontractors, such as in the Foxconn scandal, the reality is that this little bit of bad press does not affect the company's sales. Overall, Apple has an exceptionally positive social environment. People not only want smartphones, but they are addicted to them, and they have a preference for feature-rich high end phones.

The technological environment is moderately positive. One might think that it would be strongly positive, but there are some interesting trends here. The big one is that as the smartphone and tablet markets mature, the features are becoming commoditized. While the first few years of smartphones saw exceptionally high rates of innovation, more recent iterations have seen less substantial changes. For the most part, changes today are incremental. Apple is at the fore of technological innovation in its industry, but the pace of innovation is slowing. The gap between lesser phones at those at the high end of the market is starting to shrink, and that is going to open up opportunities for the price of even feature-rich smartphones to decline. This could potentially challenge Apple in the future.

Competitive Rivalry

Thus, while Apple is competing with Samsung today, in the near future it may face many other competitors. In particular, there are competitors such as Xiaomi and Huawei that are building their businesses in China, but learning how to make better phones. When these companies are able to deliver products that are relatively good at a fraction of the price of an Apple phone, they will start to erode Apple's business. There are definitely consumers that are loyal Apple customers, but not everybody is. The reality is that Apple has seen its share of the global smartphone market decline for a few years from 2012-2014, before gaining back some share with the iPhone 5. In general, however, the growth in the market is at the lower end as people start to realize that the lower end phones do what they want them to. This trend is more noticeable in emerging markets, where people have less disposable income, but may also start to be seen in industrialized markets.

This would change the nature of competition in the market. At present, Apple is locked in a duopoly with Samsung. A duopoly is characterized by two firms competing directly against each other, to the point where they might react to each other's moves. This is normally associated with decreasing profit margins, but in this case they are competing on features so they have high spending on research and development. Where this becomes a problem is if the nature of the industry changes, and some of these secondary players emerge with products that are halfway comparable to those of Apple. At such time, prices may come down a bit in the market, and the result will be a steep cut to Apple's profit margins. Spending on R&D might not have the same ROI if that happens, and the industry could begin to flatline with respect to innovation. How soon this scenario might unfold is unknown, but it is a natural part of the product life cycle. Thus, while the competitive rivalry is not bad for Apple right now, it could be with the emergence of stronger secondary competitors that can drive the price of smartphones down.

Apple's tablet business is already suffering, as consumers are starting to realize that most people do not need both a phone and a tablet. As consumers make this trade-off, smartphones appear to be winning. That will challenge the iPad's business going forward. Apple has as a steady market share in its personal computer business. The company's strength is in the consumer market, where it has always concentrated. While it is a niche player overall, its relatively low share of the enterprise market indicates that it has a relatively high share among consumers. Apple's computer business has remained fairly stable for many years, as customers tend to be repeat buyers.

Overall the competitive rivalry is not harming Apple today, but there is reason to think that in the future more entrants into the market, plus the blending of the high and medium-ends of the market might create greater competitive intensity in the consumer electronics business.

SWOT

Apple has many strengths with which to continue to thrive. First, it has an excellent team of people. The product design is iconic on several products, which gives them a distinctive look in the market and a lot of appeal among consumers. This is an advantage over many of Apple's competitors, who do not have the same visual style. Among those that do, for the most part they are directly copying Apple's style elements, cementing the idea that Apple is a leader in this regard. Apple's designers and management are clearly operating a very high level.

The company is able to attract the best people. To compete at the highest level in this industry requires a company to attract the very best people. In many cases, top talent opts to work at start-ups where they can have a high level of creative control. To overcome this, Apple has to offer an exceptional work environment and the opportunity to work with an industry leader. This has proven to be an effective combination for Apple, and they remain an employer of choice in Silicon Valley. As such, Apple has been able to withstand some staff defections, and more important they have been able grow, continually adding good people who are able to help Apple to maintain its competitive advantages.

Apple is possessed of tremendous financial wealth. A look at the company's balance sheet illustrates this. In the past four years, the company has earned nearly $200 billion in profit. At present, Apple has $41 billion in cash and short-term investments, and a further $164 billion in long --term investments (MSN Moneycentral, 2016). Apple cannot find good investments fast enough for the amount of money it makes. There are two implications for this. One is that shareholders have pressured Apple into using this capital for dividends and share buybacks to increase the return to investors. The other is that Apple has the money it needs to do whatever it wants. Any business Apple wishes to enter, it can and does. There are no financial constraints on Apple's success, or its future investments. For example, Apple is working on a self-driving car, to enter the automobile business. It can do this because of how much money it has, and how much it continues to make.

There are few weaknesses at Apple. It would be reaching to suggest that a company earning tens of billions in profit every quarter, and has probably the highest market cap of any company in the world, has weaknesses. It has the most valuable brand in the world (Interbrand, 2015), the best cash flow, and the best profitability. The only thing that could even be considered close to a weakness is that it does not have dominant market share in any of its businesses. It ranks second in smartphones, the tablet business is in decline, and it has never dominated the computer business. None of this has inhibited the company's profitability, nor its growth prospects.

There are few truly great opportunities in consumer electronics, at least not in the businesses Apple does not already perform well in. The company's best return on investment is probably just to stay the course. If Apple keeps doing what it is doing, it has the opportunity to make $40 or $50 billion every year. Doing nothing may not sound that sexy, but how many companies can say that they have the opportunity to make tens of billions in profit every year? Maybe Google, but ultimately Apple is in a highly unique situation where staying the course is about the best thing it can do. The brand loyalty it engenders will allow it to discount the influence of new competitors on the smartphone market.

That said, the company needs to take into account that there will eventually be disruptive technology in the smartphone business, and that they will want to be the ones that invent it. The technology life cycle is very short, so thinking that the status quo can be maintained for any length of time is probably not a good way to think. Consider the cell phone business. In the mid-90s, it was nascent. Ten years later it was peaking. Fifteen years after cell phones were just starting their growth, the business was dead and smartphones were dominant. iPods were huge for ten years, now Apple barely makes them. Tablets really did not have a long life cycle at all. Thus, Apple is recommended to start planning for the next disruptive technology.

One thing Apple is doing in that regard is focusing on self-driving cars, but there are other option as well. Artificial intelligence is another means by which the next disruption might occur Apple should be invested in both AI and in transportation, for a couple of reasons. With AI, there is little doubt as the disruptive potential of that technology. With transportation, there is opportunity because our entire global economic system relies on transportation, but fossil fuels are not only destructive but ultimately they are temporary as well.

This opportunity is somewhat vague, and surely the people running Apple are more in tune with how to specifically operationalize the pursuit of disruptive technology, but strategically this is what Apple needs to pursue in order to not only put its money to good use, but to ensure that it will continue to be viable over the long run in an industry known for its rapid pace of change.

The biggest threat to Apple is this concept of disruptive technology. As long as the current technology is dominant, there is little reason to believe that Apple's position as a highly-profitably company is in any danger. However, should something disrupt the market, and Apple is not in a good position, it could lose market share at worst, or at best simply miss out on a good opportunity. A good case study would be Microsoft, which largely missed the boat on mobile technology. Though Microsoft held -- and still holds -- a dominant position with its Windows operating system -- it was a late entrant into mobile. Because of this, Google and Apple had already carved out the lion's share of the market, and Windows Mobile never really took off. Windows Phone had a market share of 3.1% in 2012, and this has declined to 2.6% by 2015 (IDC, 2016). That is one outcome, but the other could be what happened to Blackberry, which went from dominant in its industry to dead in the span of just a few years, as rivals (namely Apple) leapfrogged its technology.

Strategic Recommendation Implementation

Apple has considerable talent and wealth, and it needs to find outlets for these things. In particular, the company's shareholders are seeking abnormal returns. In its current industries, Apple is incredibly profitable, and there is little that can be done to improve upon this. Indeed, our team lacks the hubris to think that we can do better than the people who are presently running Apple, because those people are the best in the world. What can be recommended, however, is that Apple use some of its considerable resources to anticipate, invest in, and develop the next generation of disruptive technology. This is not necessarily a smooth pathway. Apple famously wanted to pursue the tablet before the smartphone, only to reverse that decision when it realized smartphones had more potential. So the exact pathway of this investment is unclear, but Apple will face a situation where its industries are threatened by disruptive technology. It will need to be in control of that process, or it risks going the way of Blackberry, or at least the way of Windows Mobile.

The two best candidates for its efforts are in transportation and AI. Transportation is actually a blend of AI and energy in terms of where disruptive technology probably lies. AI is a tremendous opportunity because it holds the power to change the way people do just about everything. So many new processes can be automated at AI technology develops, and it is expected that technologies which increase efficiency and lower costs will be in high demand. There is opportunity, therefore, in the incremental improvements, long before the holy grail of AI is reached. This is an expensive industry to operate in, but Apple has the money. Moreover, Apple has access to the best people, and if it gives them the freedom to create on their own, Apple can certainly attract top talent in the field. It can also buy the top companies in the field, given both its cash and its market cap. There are multiple ways for Apple to enter this business.

It is recommended that Apple enter AI via acquisition, as a means of getting a head start. This could allow them to bring in top talent, and put that talent to work on projects that Apple has ongoing, such as its automobile project. There is a lot of room for Apple to buy small AI companies and then build on them.

The second recommendation is that Apple gets into transportation. It is doing this, with its quest to bring a self-guided vehicle to market. Self-guided vehicles are just the means to an end, however. First, the transportation industry is huge, and such a product would likely only be the first step in redefining the transportation business. Second, the key technology drivers for such vehicles -- AI and energy -- will ultimately have a lot of applications beyond just self-driving cars. This is not to dismiss cars as a potential market, however. Cars are a great market. It is a competitive business, but Apple is one of the companies that can transform that business. Even in a theoretical world where we move away from fossil fuel consumption quickly, the need for cars will need disappear, because so much of our society is built upon our transportation networks. Being able to replace those networks with products that are highly efficient, and do not run on fossil fuels, is the sort of transformative technology that can allow a company like Apple to enter and quickly build substantial share in the automobile market.

It is not recommended that Apple seeks to dominate the energy side of the market. Apple is not an energy company, and probably never will be. It should focus on AI, software, and aesthetics, playing to its historical strengths. Battery power, especially using renewable energy, is a major growth industry, but traditionally Apple is a designer and uses OEM suppliers. It can likely acquire battery technology or license it if need be. Power is more likely to become commoditized, where something like a vehicle where external design matters is less likely to be commoditized. Thus, there is more potential for a multi-decade long growth cycle in vehicles and their software than there is for batteries, even though batteries has substantial market potential.

Ultimately, these are the biggest opportunities that Apple has. In order to ensure that Apple can take advantage of these opportunities, it needs to ensure that it devote sufficient resources. This means convincing shareholders that these invests are better than dividends and share buybacks. This also means that Apple needs to bring in the right people and buy the right companies to be a leader in this field. Ultimately, Apple can do this, however, because it has the money. Thus, it is important that Apple continues earning the way it has. Fortunately, it appears to have no trouble doing this. Just when it looked like its fortunes were sliding, the iPhone 5 restored strong growth to the company. Apple is in an excellent position to continue to generate the sort of capital it will need to take advantage of these recommended opportunities.