[Not] Time to sell Apple

by Michael in ,

This started as a "→" link post but turned into its own beast.

Time to sell Apple (found via Daring Fireball)

Thomas H. Kee Jr. at marketwatch.com:

If a business fails to take care of its customers, its customers will go elsewhere. Every businessman knows this to be true, and for those who are prudently observing the trend in one of our giants, forward risks become a reality.

His first sentence and a half aren't really debatable. Let's see where he's going with this. From the same article:

In the case of Apple, this is happening in front of our eyes, and the risks are therefore very high. Apple has stopped serving their customers well, and unless they start to serve their customers better the company will begin to lose more market share and revenue and earnings projections will come down aggressively.

Hmm. Ok, so this is his thesis. I don't see this as being true, but let's see his justification. Hopefully he'll address how "Apple has stopped serving their customers well", because I'm not seeing it until he does. Contuining Kee's article:

Most people think Apple's customers are the end user, but because Apple relies so heavily on third-party resellers like Verizon and Sprint, both of which are feeling margin contraction and negative effects on earnings because of the extremely high cost of iPhones, the real customers are third-party resellers, and Apple is not treating them right. As long as margins and earnings are negatively affected by sales of Apple's products, those resellers will look for alternatives and eventually they will find them. Nothing could be clearer.

Woah. Nothing could be clearer? That's like a half-blind person stating he can't see something and, because he can't see it, no one else can. His base assumption is that Apple's customer is the carriers. His base assumption is wrong. Apple is the one and only cell phone company whose customer is in fact the end user. Google? Nope. Motorola? Nein. HTC? Samsung? Nyet and Non.

From MG Siegler's Why I Hate Android post (Warning. Language in the below quote, and more in the source link):

This was to be the dawn of the golden age of mobile in this country. As I wrote at the time: Apple And Google Just Tag Teamed The U.S. Carriers. I loved it.

But it was never meant to be.

What should have been obvious at the time but for whatever reason wasn’t (maybe because carrier representatives were at the event), the carriers hated this plan. And for good reason — it was going to turn them into dumb pipes that competed on price. There was no way they were going to let this fly, and they didn’t. Within a few months, citing weak sales of the Nexus One, Google scrapped their ambitious website and instead got fully in bed with the carriers.

But there was more.


To complicate matters further, behind the scenes, Verizon and Google were arguing over Net Neutrality rules. Verizon was opposed, Google was in favor. Then a funny thing happened. Google started supporting Verizon’s viewpoint on the matter! If you’re looking for the first post where I’m really, truly, pissed off at Google, look no further. 

It. Was. Total. Fucking. Bullshit.

A few months later, guess what happened? Thanks to the Google/Verizon alliance on the matter, the FCC decided the compromised vision of Net Neutrality was just fine also. To be clear: Net Neutrality was thrown out in the wireless space because Google sided with Verizon’s ridiculous and horribly conflicted stance on the matter. 

The open spectrum enemy, turned Net Neutrality enemy, became Google’s bedmate thanks to a business deal. Straight up. Greed, for lack of a better word, is good.

We got all of this thanks to Google’s desire for Android to take over the world. I commented earlier that they signed a deal with the devil — I wasn’t being facetious. They actually did! And they got away with it!

Google's customer is not the user. Google's customers are advertisers who pay them to put up ads and every decision is made in order to increase the number of eyeballs that see those ads.

Here's a follow-up to Siegler's article by Watts Martin at his blog, Coyote Tracks:

And if you don’t agree with Siegler’s assertion that Apple, for all their warts, has more of the end-user’s interest in mind than Google does, I’d just like you to do one simple test. Go into an AT&T, Verizon, or Sprint store and set out a few Android models along with an iPhone and maybe a couple “none of the above” smartphones they sell. One and only one of those phones is going to be entirely free of the carrier logo. Don’t be under the illusion that’s merely an aesthetic issue.

This is not to imply that no one at Google wants the end user to be its customer. They have great people working at the company with the end user in mind. There are certainly individual features that are better for the customer than the lack of that same feature in Apple's devices. The people designing those features are, however unfortunately, required to sacrifice their vision's execution as a whole in order to serve the carriers--because Google has made its goal having as many Android phones sold as possible rather than putting out the best products to customers it can (Siegler's article explores thoroughly the original vision of Android and why what we have instead is so deficient in comparison). Even Google's newest flagship device, the Galaxy Nexus, has been compromised at Verizon's request (regardless of what Verizon's PR says).

Sure, at this point you can interpret what I'm defining as Apple's customer and what Kee is definining as Apple's customer are two different things. You could argue that he is saying Apple's customer should be the carriers because the carriers sell the cell phone while I am arguing that Apple currently sees users as its customer. In this context, then, you would say that Kee's proposition is that Apple is serving the wrong people and needs to change tracks. Well, his proposition is wrong.

Apple's customers have been, and always will be, the end users. It's why they make the entire package. Their deals with carriers are reluctant ones--much like Google's deals initially were (the difference being Google decided to sacrifice their product and ecosystem vision while Apple makes minimal carrier concessions). Rumors have it that Steve Jobs initially wanted to bypass the wireless carriers entirely with some kind of unlicensed spectrum network with the original iPhone. Unfortunately, such a solution was not feasible, and so Jobs did the next best thing: prepared its own cell phone with absolutely no carrier software (or "experience") on board and shopped it around to different carriers. Its first pick? Verizon. Verizon said no because it knew customer-oriented products would be bad for its bottom line. So it ended up with then-Cingular-now-AT&T as the sole carrier for the iPhone. AT&T sold the device prominently and gained a foothold with the competitive advantage the iPhone provided. At this point Verizon reluctantly had to deal with Google to start getting Android phones on its network in order to compete. This is key, though: Verizon has never wanted an experience outside of its control on its network. Even now, Verizon & AT&T make manufacturers change their devices to suit their desires.

There are two losers here:

The first is the entire group of cell phone manufacturers: HTC, Motorola, and Samsung certainly wish they could make products not hamstrung by the carriers (this topic could be a huge string of blog posts of its own now that everyone is trying to manufacture their own ecosystem). Apple is the only company that has such strong sway with customers that the carriers are essentially forced to accomodate its devices unless all carriers simultaneously decided not to allow iPhones on their networks (which they would never do, because if all but one didn't that one would have a huge advantage--like AT&T did at the iPhone's launch). The carriers are stuck with Apple. The minute Apple starts bending to the will of the carriers with alternate SKUs is the minute Verizon and AT&T stop bothering to pretend to sell the product Apple wants to sell (the "stock" iPhone which would equate to Google's excellent Nexus One or current Galaxy Nexus) in favor of the carrier branded one (the equivalent of the Droid line, which Verizon has been advertising heavily while doing everything possible to ignore the Nexus). When that hypothetically happens (it won't), the image of Apple's user experience will be sacrificed--just as the image of Android's user experience is the one users actually have--rather than the ideal one provided by Google's vanilla and well supported implementations.

Apple was making record profits on just one carrier in the US and the US is a decreasing percentage of Apple's profit. Apple doesn't need all the carriers in one single market to make immense amounts of money (though it helps quite a bit). The carriers, though, need Apple to avoid hemorrhaging customers to whichever competitor has exclusivity--even more now than ever now that their customers have had a taste. Apple wants the carriers on board, but the carriers need Apple. Apple's position of power here is entirely dependent on it contuing to treat end users--rather than the carriers--as the customer. The customers who want iPhones are Apple's power over the carriers. The other manufacturers might all wish the end user was their customer, but they don't have the power offered by customer desire to operate that way. Apple is the only company in this particular industry focusing primarily on the customer--not out of some sense of altruism, but because it knows it is a huge competitive advantage to be doing so in an industry in which it is inherently difficult to gain the freedom to have such a focus.

The second loser is the entire group of customers because the quality of competition in the experiences provided by products is reduced by the carriers. (Granted, I'm not sure these other phone manufacturers would have any idea what they're doing if given the option. Samsung seems to actually think TouchWiz is a worthy platform in and of itself--so worthy that it won't update products to the newest Android operating system if they can't handle TouchWiz on top of it. Other manufacturers don't seem to be thinking much differently.)

Back to a previous quote from Kee's article, he is absolutely right when he says, "As long as margins and earnings are negatively affected by sales of Apple's products, those resellers will look for alternatives", but we don't know if he's right to continue with "and eventually they will find them." Even if the latter part of that sentence turns out to be right, he's completely wrong to state that Apple trying to serve the carriers is going to help. Apple simply has to make their products so desirable to end customers that the carriers will lose more money in lost customers if they drop Apple's products than the extra money they could make on their higher margin phones and services.

Continuing in the article:

In addition, Apple is changing as economies of scale are catching up with it; the company is starting to look for recurring revenue streams by offering cloud, and this has striking characteristics to the service model that has kept IBM in good standing throughout all recent market turmoil. Everyone knows IBM is just a slow-growing giant now, and although the recurring revenues come from a different source, Apple is also headed that way.

This is not how economies of scale work. Apple's products are getting ever cheaper to produce at rates far beyond its competitors--because it's selling more units with less variance in configuration than anyone else. If anything Apple's economies of scale are making it EVEN EASIER to stay ahead. Apple's economies of scale are only helping it to produce hardware cheaper than everyone else at ever-increasing profit margins. There is a reason competitors in the computer business can't make hardware equivalent to the MacBook Air at competing prices without a $300 Million production subsidy from Intel. That same reason allows Apple to continue to make money hand over fist on the iPad 2, 8-9 months after release, while competitors are still struggling to make money on similarly priced and similarly specced hardware. That reason is economies of scale. One wonders if Kee is simply throwing out buzz words in the hopes people won't bother to actually think about whether they apply to anything at all relevant to the point he's trying to make.

Further, Apple is not getting into cloud service for recurring revenue streams. It only charges for one (iTunes Match) and even then it's almost certainly only charging for that niche service in order to appease record labels. Apple's cloud services are entirely made using profit made from its hardware in order to add value to those same hardware devices. Apple sells devices with supplemental services serving as features (rather than say, Amazon, who sells highly discounted hardware in order to make money on its services). This was the point of iTunes--to provide a service people wanted enough they'd buy iPods. It's the point of the App Store as well. Sure, Apple makes money on iTunes and the App Store, but that money is a drop in the bucket compared to its profit from hardware sales, accounting for less than 5% of Apple's total Q4 2011 Revenue (those services don't even qualify for an entire section of the revenue chart--falling under "other" instead).

More Kee:

To any doubters, look at the past growth rates versus current market multiples; Wall Street already sees this coming.

Wall Street has seen this coming for ages, and they've been continually wrong. (Read here and here). No, Wall Street previously being wrong doesn't mean they're also wrong this time. but we also have no particular reason to believe they're right when all of their very specific predictions have been wrong thus far. It's completely valid to say Apple is going to eventually slow down in growth because of X, Y, and Z valid points at some indeterminate point in the future. It's a whole separate point to say Apple is going to perform at X not-good rating and then turn down without justification. And then there's the fact that Kee is trying to use the comparison of "past growth rates versus current market multiples" as evidence when the numbers have pointed to exactly the same thing for years now with it meaning nothing. Wall Street's understanding of Apple is inherently broken. As such, their predictions of a downturn are broken. If they're right, whenever they end up right (because one day Apple's value will inevitably decrease), it will be entirely incidental. As they say, a stopped clock is right twice a day (unless you're a digital clock--then you're never right if stopped--oh man, who's the stopped digital clock in this case?).


I am not suggesting that Apple is going to fall into peril, but the easy money has already been made.

No, it hasn't.

Replacement phones will continue to be purchased every two years or so for some time. Phones get physically abused and the rate of improvement of hardware is still significant. Recurring purchases will continue to bring in large amounts of money. (Besides, the smart phone market may now be a majority of the cell market in the US, but it can still grow quite a bit.)

China is a market with at least 800 mobile phone subscribers. This is a conservative estimate--the largest carrier, China Mobile, alone has 600 million. There is insane room for explosive growth by Apple in China.

Steve Jobs put it best in his January 2007 iPhone announcement keynote: In the first year Apple wasn't looking at the "smartphone market", but instead the mobile phone market. They were shooting for 1% of the entire mobile phone market at the time. Right now, Apple makes over 50% of the entire mobile industry's profit--while only just passing 5% of the entire mobile phone industry's market share in October. Obviously the easy money has already been made.

Finally, also from Kee's column:

After a while, selling a $500 slight upgrade to consumers who are strapped for cash will not produce the same results, we all experienced that with the iPod, but that is just the beginning.

No. We did not experience that with the iPod. People still buy iPods in huge numbers. While iPhone revenue is certainly decreasing, that's because people are buying iPhones instead. People have been purchasing fewer dedicated audio devices because of the rise of general computing portable devices which serve the same role as iPods... an industry created and led by the iPhone.

I'm not going to say everyone who implies now is the time to sell Apple stock is wrong, but Thomas Kee is. There are compelling arguments for looking into selling Apple stock and investing elsewhere (perhaps opting to invest in smaller companies with similar growth while being earlier in their curve--I'm sure someone could flesh this out better than I), but Kee offers none. Even if the stock tanks tomorrow (unlikely), it won't be because of any of Kee's unsound logic or erroneous conclusions. It doesn't matter if a statement you make ends up coinciding with how events play out (though I'm dubious here). If you have no fair justification or reasonable reason to think what you do you're not right. You're just really lucky.