APPLE CASE

THE APPLE CASE [adapted and updated from U. Bertelè, Strategia, Egea] Apple & Steve Jobs: a successful strategy Apple is an American multinational corporation that produces operating systems, computer and multimedia devices [...]. Founded in 1976 and known all over the world thanks to the wide range of Macintosh computers since the early eighties, his name is currently associated to the digital music player iPod, the online music store iTunes Store, the iPhone (a smartphone based on the iOS operating system) and the iPad tablet as well. [...] It introduced many innovations for the large consumer market in the field of high technology and design applied to computer products. [...] On August 30th, 2018, Apple Inc. got the highest capitalization, with a value of $ 1.087 trillion. In September 2018, the market capitalization of the company has been around $ 1 trillion, as shown in the figure below (Source: https://ycharts.com/companies/AAPL/market_cap). Looking at Apple’s strategy from 1997 to now – from the Steve Jobs comeback as the company CEO to the years following his death (when the implications of his latest initiatives were still strong) – is very instructive. It allows to understand how the profitability and the enormous increase in the company value have been not only the result of the ability to innovate products (and change people lifestyle) and business model, but also of the ability to take decisions meant to widen the gap between revenues and costs. The three products that have dramatically increased revenues, net income and company value, i.e. the iPod, the iPhone and the iPad, launched a few years away from each other, are similar by nature: they are electronic devices, hence physical objects, nevertheless drawing a key part of their interest from being access terminals to a range of services provided (through exclusive agreements) by a very large number of other actors involved in the so-called ecosystems: from firms operating in the music industry, for example, that through the iTunes Store allow to download songs and other multimedia contents (at a fixed amount); to publishing companies and independent apps producers, which respectively sell news and apps through the App Store; they are physical devices very easy to use, with a strong focus on design (both in terms of aesthetic and functional design). They share the same target customers: the high-end consumer market at worldwide level, namely private consumers, which are willing to pay a “premium price”. Nevertheless, both the iPhone and even more the iPad (which is seen an alternative to the PC for several applications) have had an increasing success in the B2B market as well, significantly contributing to the so-called “consumerization” of such market (i.e. the adoption by enterprises and institutions of these devices for private use by its employees). At the time of their launch, all these products enjoyed a very high degree of innovation in the design and performance, although not necessarily in the physical technology (MP3 players, smartphones and tablets were pre-existing). Such innovation has paved the way for the emergence of new markets, where Apple has managed to keep remarkable positions over time. In the case of the iPod, the development of a serious competition was blocked by the difficulty for potential new entrants (including Microsoft) to create a competitive ecosystem. Only recently the iPod dominance – lasted about a decade – has been undermined by the growing success of the music streaming (by companies such as Spotify) compared to the traditional iTunes download. The growth of the music streaming, of which the revenues in US market exceeded those of physical cd in 2014, undermined the dominant position created by Apple, through its “iTunes store”, in the distribution of the digital music. In order to respond quickly to this threat and to fill the gap created by new consumer preferences, Apple decided not to internally develop a streaming service (a move that would have required a long redefinition of contracts in place with the music majors), but to go through an acquisition. In August 2014, Apple announced the acquisition, for $3 billion, of Beats and the related service of the target company, called Beats Music, which in 2015 became Apple Music. In the case of the iPhone a rapid replacement process of mobile phones with smartphones has taken place and as a consequence the weight of the incumbent companies (like Nokia and BlackBerry) has strongly decreased. Apple has remained at the top for the overall profitability (app included) with its proprietary operating system. A vigorous competition quickly arose that brought Android (open operating system made available free-of-charge by Google) and Samsung to a leadership position, respectively in terms of total number of installed operating systems and smartphones sold. In the case of the iPad, more and more seen as an alternative to PC by many kinds of use, competition from Android and Samsung met greater resistance and the competitive advantage in terms of perceived quality has allowed Apple to maintain greater control over the high-end market segment. The revenues from Apple’s main products are shown in the next figures. As far as the whole product portfolio of Apple is concerned, in September 2015 the company has even launched a new product, the Apple iWatch, with the aim to compete also in the watch industry. Despite the important promotional campaign of this product, the Apple iWatch has had some problems of sales, as shown in the next Figures. In some days, the company was selling just 10.000 watches, with sales dipping to as low as 4.000 to 5.000 units per day in late June 2016. Despite the product has been improved and in 2017 has been marketed the “Series 3”, the market size is very weak if compared to Apple’s core products. The closed nature of the proprietary technology has strengthened the capability of the different devices and the Mac – the Apple PCs that in the meantime have increased their market penetration – to communicate each other, also using the new iCloud service: a winning choice thanks to the steering effect that the success of a product has on other products. However, it has been threatened by the introduction in the mid-2013 by Dropbox of a platform that allows the same type of synchronization between devices of different nature and brands. The closed nature of the proprietary technology and the ambition to keep control over its customers also led Apple to try to prevent from the use of very popular software and apps on the iPhone and iPad, such as Adobe Flash Player and Google Maps. However it had to take a “step back” from this strategy due to a clearly lower performance of what offered as an alternative. They finally shared the fact that their manufacturing process, as well as the Mac, is completely outsourced to Asian contract manufacturers, with a particularly important role of Foxconn. More than one million people work for Apple outside of the USA. In a phase of strong employment problems there was a request by Obama to “repatriate” at least part of the production process, which was rejected by Steve Jobs and accepted to a lesser extent by his successor. Several problems are also related to the working conditions in Asian factories, which have repeatedly threatened to damage Apple’s reputation. The role of R&D ... but not only The ability to innovate products (and change people lifestyle) and business model, also shown by the award of The World’s Most Innovative Company in 2016 and 2017 received by Forbes in the annually compiled ranking by The Boston Consulting Group, was certainly a key ingredient for the profitability and the increase in company value. Which role did the new products research and development play in this scenario? The answer is quite surprising, because the Apple R&D expenditures is less relevant if compared to the big ICT global companies. It spent more than $ 10 billion in 2017 compared to a turnover of about $ 215 billion (4,65%) and about $ 48.351 billion net profit (22,48%). In absolute terms the R&D expenditures rose about 2 billion on the previous year (around $ 8.1 bn in 2016). Apple is on track to spend more than $ 12 billion on R&D in 2018, a 20% increase with respect to 2017. In 2017, Microsoft (with $ 93.6 billion turnover and $ 20.539 billion net profit) invested $ 12 billion in R&D activities. Alphabet (with a $ 75 billion turnover and $ 19.478 billion net profit) invested $ 12.3 billion in R&D activities across its many businesses (Source: The 2017 Global Innovation 1000 study – Investigating trends at the world’s 1000 largest corporate R&D spenders: https://www.strategyand.pwc.com/innovation1000). Possible explanations are: the ability to understand the potential of innovations developed outside the firm and to use them to develop new innovative products about concept and functionalities; the substantial reliance on R&D investments done by suppliers (forced to adapt the supply to Apple needs), including Samsung for some critical components; the substantial reliance on innovative start-ups acquisitions (“open innovation” approach, as in the case of Siri voice recognition, as well as Beats, previously mentioned). The company image has certainly contributed to the company value growth as well, with its impact on both the overall sales volume and the customer loyalty. Loyalty is not only important in the phase of product replacement but often pulls the purchase of other products of the Apple portfolio. Other factors played a role in building the company’s reputation such as product and stores design. The power of the Apple reputation is also revealed by the first position for the tenth time in the World’s Most Admired Companies ranking (followed by Amazon and Alphabet) published by Fortune in 2017 (Source: http://fortune.com/worlds-most-admired-companies/). In the BrandZ (Top 100 Most Valuable Global Brands ranking), the company was in the first position for three consecutive years (followed by Google, IBM, McDonald’s and Coca Cola) from 2011 until 2013. It was in the second position in 2014, again in the first in 2015, and again in the second in 2016, 2017 and 2018 (after Google) (Source: http://www.millwardbrown.com/brandz/top-global-brands/2018). The brand equity – even though not easy to measure – is correspondingly high. It is around $ 147.311 billion, at the second place after Google (around $ 150.811 billion), according to 2018 Brand Finance ranking with a growth of more than 37% on the previous year (Source: www.rankingthebrands.com/The-Brand-Rankings.aspx?rankingID=83&year=1200), and with a growth of more than 5% on 2015 according to 2016 Interbrand ranking (Source: https://www.interbrand.com/best-brands/best-global-brands/2016/ranking/). Apple’s profitability depends on two other important factors: the very low level of taxation, due to a tax optimization strategy known as the “Double Irish With a Dutch Sandwich” (which brings together the profits in Caribbean “tax havens” after passing through the Irish and Dutch subsidiaries); the low production cost, thanks to the exploitation of low-cost workforce. Regarding the first point, Apple pays taxes on the profit earned abroad of 2%, compared to the 35% paid on average in the USA for profits recorded therein. Therefore, it is obvious that the capitalization is substantially affected, although a more detailed assessment of the impact is not immediate: Apple may in fact simply transform savings into additional profits or use them at least partially (as apparently does) to set the products prices ranges in order not to negatively impact on sales volume. The other area in which Apple has been particularly involved is the legal one. Apple implemented both offensive and defensive strategies. It valued its patents: by charging royalties to imitators, asking even the courts (as is often the case with Samsung) to inhibit the sale of products that have violated them, purchasing at very high prices patents from other firms in order to avoid allegations of patent infringement by the same or to obstacle competitors willing to use them. Blue and red oceans The word “strategy” comes from the military jargon and evokes the war. Two questions: Has Apple grown only through competition? Against which opponents? The answer to the first question is no. Apple grew from 1997 to 2016 through the implementation of a strategy that W. Chan Kim and Renée Mauborgne defined “blue ocean”, i.e. offering to the potential customers innovative products instead of competing in the “oceans red” where there are already many competitors. It created enormous upsetting, for example destroying the leadership of Nokia in the mobile phone through the iPhone, without entering into a direct conflict with it (due to the product innovativeness). It devoted itself almost exclusively to the acquisition of customers: this was true until the “real” competitors (e.g. Samsung-Google in the smartphone business) came into play and therefore the ocean began to change color and became red. The answer to the second question is complex because of the huge transformations that occurred in the ICT sector. On the one hand, there is a strong competition among companies previously leaders in their own market (e.g. Google in the search industry, Amazon in the e-commerce industry, Microsoft in the PC operating systems and software industry). On the other hand, they appeared “big-bang disruptions” in sectors previously completely separated (music, books, newspapers, payments, etc.). The answer is made more complex by the variety of roles played by such competitors. For example, Samsung is the main competitor in smartphones and tablet market, but at the same time it is an important supplier for critical components. Google with its operating system (Android) is the main competitor for smartphones and tablets operating system, but it achieves a remarkable portion of its revenues thanks to the popular apps still running in almost all the iPhone and iPad (despite several attempts by Apple to exclude them). Apple has become the strongest competitor of the big traditional player of the game industry (Sony, Nintendo, Microsoft) given the widely diffused use of iPad as a PlayStation. But, it is not the direct competition in the different sectors which may affect the profitability. There are other players putting pressure on Apple’s profitability. Contract manufacturers and suppliers in general requiring higher margins, the partners who sell through Apple’s store such as music and film makers, app makers, publishers (who pay 30% to Apple to publish their online news), the sales networks, the telecom companies who would stop to give iPhone and iPad to acquire their customers and sell them connectivity services. These players are “competitors”, they do not compete for the market share, but they compete for the margin split. So far, the strategy implemented by Apple has been able to take full advantage of the innovation and the quality of the output to enhance the image and strengthen his grip on final customers; to increase sales at a premium price; to have a greater bargaining power towards suppliers and partners. This strategy has been rewarded by the stock market – sensitive (as well known) to a firm profitability and growth – with an impressive increase in capitalization, that reached the figure of more than $ 1 billion in August 2, 2018. An important contribution to the Apple growth is due to the expansion on international markets. In 2015, the results of the company from greater China are outstanding, with revenue growth of 112 percent and iPhone unit growth of 87 percent. This is particularly impressive given IDC’s estimate of only 5 percent for the greater China smartphone market. Apple also achieved the highest-ever PC market share in the segment, with Mac sales growing 33 percent over last year. However, sales were down year-over-year (from July 2015 to April 2016) across product categories and in many regions, including the previously high-growth region of Greater China. Only more recently, sales seem to be going up on international markets. A sustainable strategy? Probably the stock market is wondering whether the Apple strategy is sustainable. There have been adjustments in the capitalization: for example there was a fall from September 2012 to August 2013 from $ 450 billion to a value lower than $ 400 billion, then in 2016 the market value was lower than the year before. Such trend could be attributed to emotional factors or to large speculative bets, but that reflected the doubt that the period of disruptive innovations and the tumultuous growth was over – also because to the difficulty of finding a “new” Steve Jobs – and that Apple was forced to return operating red ocean businesses. A quite reasonable doubt, for several reasons. It could be expected that – while committing and investing more and more resources in R&D activities – Apple will be no longer able to put on the market new “disruptive” products, which are able to create new customer needs on a large scale as happened in the previous years. It is launching innovative products, like for example the watch or the TV – reinterpreted in their meaning – but with no breakthrough. It continues to work on the performance of its flag products, but with incremental innovations that fail to avoid flattening the grip and the transition to a competitive market, which is typical of the maturity stage. The competitive advantage related to product innovativeness is reducing, as well as the one (even less defensible) related to the product and retail stores design, resulting in a lower grip on the consumers and their lower willingness to pay premium prices. Suppliers and partners roll over their supply and partnership conditions in their favor. With two other potential risks: the development of new tax rules in order to eliminate or reduce the “bugs” that currently Apple (and multinational companies in general) largely relies to avoid taxes; the growth of production costs, resulting from the increasing claims by low-cost workers in Asian countries. If this hypothetical scenario will occur, the annual profits (considering the as-is situation, i.e. in the absence of significant acquisitions or divestments) would be reduced and the decrease in the capitalization would be justified. The same happened in the past to several leading companies with an extremely high levels of capitalization: e.g. to IBM, with the transition from mainframe computers to distributed IT or to Microsoft and Cisco with the “new economy” crisis. With very different results. IBM ($ 79.139 billion revenue, $ 5.753 billion profit, in 2017, and with a $ 132.76 billion capitalization, in 2018) has refocused, abandoning sectors where it was still strong (such as PC industry) and focusing on the most innovative areas of B2B. Microsoft has gained almost the half of its market value ($ 829.78 billion in 2018) compared to the peak reached the previous year ($ 566.42 billion in 2017), much higher than Alphabet (about $ 814.76 billion in 2018), and much higher than Samsung ($ 320.85 billion in 2018). Cisco had its high at the peak of the Internet bubble with $ 300 billion of capitalization, which then fell down to 100 billion, to later grow to about $ 221.27 billion (in 2018) thanks to a focus on B2B market. Nokia lost most of its capitalization and sold the mobile phone division to Microsoft. Kodak failed. Who decided the Apple’ strategy? Who decided Apple's strategy in the period under consideration? No doubt, Steve Jobs, with very little interference from the shareholders and the board of directors, after he (once called back as interim CEO) managed to save the company from bankruptcy in the late nineties; with an increasing power following the success of the company since the early 2000. Apple, like the vast majority of the American public company, did not (and still does not) have an “owner”: around two-thirds of its shares are owned by institutional funds (investment funds, etc.), which are a-priori unstable due to their purpose to achieve capital gains and thus maintaining the CEO in its position as long as the company results are satisfactory. The boards of directors – in the absence of stable shareholders – are characterized by the presence of independent directors (often suggested by the CEO) and largely tend to stay there (with a small number of changes). Not even the organizational structure has had a significant weight in the strategy definition. First, because Steve Jobs ran the company as an “emperor”. In addition, because Apple’s strategy – i.e. products designed with a radical innovation logic, in extremely limited number and without any adaptation to the specific or local needs – has left little room both for new initiatives and incremental innovations. 7