Quick Thoughts: WHAT IF – Jeff Bezos ran Apple?
– Apple beat consensus and fell to under 11x trailing EPS, while Amazon missed, rose and trades at an imaginary multiple vs. its TTM losses – clearly future glory beats past glory.
– Jeff Bezos invests his potential profits and cash flows pursuing attractive long term opportunities. So far, Tim Cook has stockpiled cash and milked the high margin franchises for more
– Apple no longer has scale, cost, or technology advantage, and competes against rivals willing to subsidize device sales to secure future profits from ads and services, dooming a status quo strategy.
– Apple’s valuation gives Cook the opening to guide for MUCH lower margins, compete aggressively for share in phones and tablets, and build a real cloud business to drive future growth – a la Bezos.
By now, Tim Cook must be accustomed to being second guessed. Every major decision gets run through the “What would Steve Jobs do?” treatment by the cult-worshiping blogosphere and by tech journalists willing to beat an angle to death in pursuit of a vivid headline. For me, and I am not nearly the Jobs scholar that many Apple fanatics are, I suspect that Steve would be doing most of the same things that Tim is doing. Yes, Steve would likely have been able to keep Scott Forstall in place, and maybe, the launch of Apple Maps may have been handled with greater aplomb, but the strategic roadmap that Apple has been following was plotted with Jobs’ considerable input. The iPod was sharp design and perfect timing. The iPhone was pure game changing genius. The iPad was faith and muscle, in a product concept that no one else believed in. One, two, three – these franchise products put Apple far out in front of the pack, with iconic design and peerless device engineering earning price premiums, and with scale economies and operational excellence driving industry best costs, a potent recipe for thick, tasty margins. Unfortunately, that strategic roadmap seems to have been plotted with an early version of Apple Maps since it appears to be sending the company directly toward a distant cliff.
Part of it is that Apple has been coasting. R&D has been running at less than 2% of sales, far below rivals like Samsung (6%) and Google (14%). For its R&D spend, Apple has historically delivered a single annual update for its iOS software platform, an annual update to its ARM-based processor design, a new iPhone model for Christmas, and a new iPad in the spring. Meanwhile, Google was doubling up with new Android releases every 6 months, Qualcomm, Nvidia, and Samsung were leapfrogging each other with new chip designs, and the big Android phone makers – Samsung, Motorola, HTC, LG, Huawei, and others – were slugging it out with broad differentiated product lines with new model roll outs at least twice a year.
Apple let the competition catch up – its once iconic designs are no longer fresh, its devices are no longer unequivocally the best, and its costs are no longer dramatically lower than its rivals. The legend of Steve has the legion of fanboy bloggers and analysts sorting through indiscreet comments by Apple suppliers and blurry spy photographs to divine the “next big thing”, perhaps the mythical Apple television set that has been just around the corner for three years. The reality is that the smartphone and tablet markets are growing so large that none of the devices rumored as the next leg of the strategy could be big enough to take up the slack if the iPhone and iPad stopped bringing home the bacon.
That is the strategic cliff. Android and Windows Phone models are good enough and sexy enough to take share at the high end, particularly during the interminable waits between new iPhone releases. Carriers with alternative products to champion gain leverage and insist on iPhone subsidies more commensurate with their other suppliers, forcing Apple to accept lower prices to remain competitive for its bread and butter high end consumers. Meanwhile, Apple eschews the lower end, where huge growth in emerging markets is creating hundreds of millions of new Android users each year, reversing Apple’s scale-based cost advantages in the process.
The tablet market could prove to be worse than smartphones for Apple. Because most tablet sales are not subsidized by wireless carriers, consumers are exposed to the full price of the device, taking away a big multiplier in Apple’s margin math. Expert witness testimony in Apple’s epic patent litigation with Samsung revealed that iPad gross margins were roughly half those of the iPhone – tough, when the demand for tablets is growing twice as fast as the demand for smartphones. Furthermore, the iPad is still less than three years old, and it has had reasonable competition for only half of its life. While critics still praise the iPad for its smooth user experience and specially adapted tablet apps, the competitors have narrowed the quality gap considerably. Worse yet, the competition is led by Amazon and Google, both willing to sell their tablets at their manufacturing cost, waiving device margins now in favor of generating e-commerce, electronic media and advertising profits over the life of the product. Apple’s new iPad Mini launched at a 60% premium price to the $199 asked for Amazon’s Fire HD or the Google Nexus 7. As rival products edge closer to the iPad in quality with each generation, Apple will be forced to bleed either profit margin or market share.
The market understands this equation implicitly, hence the swan dive for Apple shares over the past several months, and the journos and blogistes are back with their “What would Steve Jobs Do?” articles. For me, the better question is “What would Jeff Bezos do, if he were in charge of this mess?” and I think that the answer would be a radical rethinking of the high price, high margins elitism of Apple’s legacy strategy, with tactical steps along the lines of:
Reset investor expectations – The stock is more than 35% off of its September highs, trading at just over 10 times trailing earnings. Obviously, investors no longer believe in the story of mid-teens EPS growth against a trend of decelerating sales and declining margins. Bezos would acknowledge the obvious, but highlight the long-term growth potential inherent in really expanding the services it offered to its loyal customer base. For the foreseeable future, gross margins would be much lower, and growth would reaccelerate once the investments in cultivating that expansion pay off.
Lower prices, broader product lines, frequent updates – The iPhone trails Android in global smartphone market share 75% to 15%, and the iPad is at imminent risk of dropping below 50%. For Apple, the market share trend is alarming and must be reversed. This means pricing its high end products competitively and offering inexpensive, entry level devices, even if that sees gross margins down by a big fraction. The smartphone and tablet product lines should expand to leave no major segment of the market uncovered, and the products, including the underlying software and semiconductor platforms, should be updated on an aggressive 6 month schedule. This would be costly – fewer products and long product lives allowed manufacturing costs to ramp to their sweet spot, typically 6-12 months in, when gross margins could be maximized.
Invest in R&D and Infrastructure – R&D would have to rise just to accommodate a more aggressive product development schedule, but CEO Bezos would put more money to work investing in new capabilities. iOS needs to be backed by world-class cloud applications, and iTunes, iCloud, Siri and Apple Maps don’t cut it. This would mean hiring talent, building data processing infrastructure and shifting the company’s culture to value the cloud as highly as they value the device. It would mean advancing the state-of-the-art in voice and gesture controls, video streaming, ad serving, content curation, social gaming, maps, electronic payments and a variety of other elements of the emerging portable user experience.
Shift Profit Focus to the Cloud and Open Integrated Apps to Other Platforms – Apple brags of having 450 million credit cards on file, dominates music downloads, and has a largely captive audience of hundreds of millions of iOS devices, yet just 5% of its revenues come from on-line services, most of that from iTunes. As Apple CEO, Bezos would attack these unexploited opportunities – expand the on-line store to new products, launch music and video streaming services, establish an electronic wallet for both mobile and on-line commerce, break into on-line advertising in a big way, and – drumroll please – make all of Apple’s homegrown apps available on Android and Windows. Apple could have a $100B+ cloud business at attractive margins, by most standards. It needs to go after it before it gets away from them.
Go for the enterprise – Bring your own device (BYOD) support at many enterprises acknowledges the grassroots for Apple in a business context, but the company’s closed platform and high price point strategy is an enormous obstacle for most IT managers to get past. Bezos could loosen the iOS platform to allow some level of customization and support for legacy applications, including virtual phone appearances. The availability of a full range of form factors and price points might ease concerns over single vendor sourcing. Apple could develop a suite of enterprise focused apps – secure messaging, device management tools, productivity applications, etc. – designed for iOS and Mac, but available across all industry platforms. Assuming that investment brings Apple’s own distributed data center infrastructure up to snuff, it could also enter the cloud hosting business, a la AWS.
Make Acquisitions – Apple has nearly $140B of cash on hand. If Jeff Bezos were CEO, he might not return it to shareholders, but he would undoubtedly put more of it to work. Investments in R&D, skill building and infrastructure would take up some of it, but many of the farther afield initiatives could be jump started with acquisitions. Cook, and Jobs before him, had been reticent to take on more small bites, but a more Amazon-like Apple would be bolder. Apple could move ahead in its cloud presence with any number of purchases, such as Twitter, Pinterest, or Tumblr. It could jump start streaming video with Netflix or negotiate Hulu away from its owners. It could make a play for mobile commerce with Square or eBay. It could enter the hosting business and get infrastructure knowhow with Rackspace.
However he proceeds, Tim Cook will be navigating territory unfamiliar to recent generations of Apple investors and employees. As long as analyst forecasts reflect an unrealistic return to the halcyon days of hyper-growth and outrageous profitability, the specter of painful guidance and downward revisions to come is likely to weigh heavily on the stock. By taking at least a page out of the Bezos playbook, perhaps Cook can reset expectations and use the lemons to make lemonade.
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