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When I posted my earlier article on Apple (AAPL) last week, there were many doubters. While informed dissent is always welcome, the emotional reasons for owning AAPL outweighed, for many, the underlying shift in the business environment. The fundamental premise of my previous article is that the business 'eco-system' that Apple has today (this includes its supply chain, competitors, customer value proposition, market evolution etc.) would force Apple to answer a difficult question about pursuing market share (at declining profit margins) or retaining its high margins (but consciously accepting a lower market share).

Well, a lot can happen in one week. After I wrote my previous article, a report from Strategy Analytics confirmed that Samsung SIII is the best-selling smartphone in Q3 2012, having sold 16 million of them in the most recent quarter. While Apple is still the leader in the total number of high-end smart phones sold last quarter (including both iPhone 4S and iPhone 5, which sold 6 million already since launch), this is the first time since the smartphone 'wars' began that a single competing model overtook Apple's offering. This marks an important 'moment of truth' for Apple in the vibrant competitive market in high-end smartphones. AAPL has declined by nearly 15% in the last month, and this cannot be explained fully by broader market declines (6.5% for Nasdaq and 4.8% for S&P 500) - see comparison chart. Even if one applies AAPL's beta of 1.21 and goes by 'capital asset pricing model' (a favorite of business school finance professors), the 'predicted' decline compared to the S&P 500 for the same period considering AAPL's volatility is about 5.8%, which is just above a third of its actual decline.

Much like the 'undecideds' in the recent U.S. Presidential election, a large segment of consumers cast their vote with their wallets at the time of purchase, since they don't carry strong opinions on either brand and make decisions based on other factors and can get influenced at the point of purchase. The 'undecideds' who rely on comparisons like this or that, would more likely choose Samsung SIII. When one reads about 20 articles from decent tech authors on comparisons, an interesting trend emerges - for comparisons on aesthetics, iPhone 5 seems to score better than SIII, and if the comparisons are on features and flexibility, SIII scores better than iPhone 5. So, if large majority of 'undecided's' go for features/flexibility and also, for price (especially in important emerging markets like India where carriers don't subsidize the phone), it is not surprising that SIII's sales numbers give it the top spot.

In moments like these where the No.1 position in a flagship model has been challenged, the top management of the competitor (whose leadership has been challenged) huddle together in a room and develop strategies for protecting their share. Having been part of such high-profile meetings in another segment of the consumer products industry, I can share with you that the strategies generally hover around 3 themes: Innovation, near-term Competitiveness and Partnership. Let's hypothesize how such a meeting may play out at Apple, shall we?

Those who advocate the Innovation theme will talk about increased R&D investments, which have long-term reward potential but will result in short-term hit in P&L (typically, for the first couple of years). The M&A department will make a shortlist of companies to buy to fill the innovation 'gap'; taking advantage of recent events, they might even stir up 'buy at all costs' mindset, which often leads to over-paying. Those who take the Competitiveness theme will put the Innovation team on defense saying we don't have 2 years to wait till all your strategies pan out, we need to do something now! This camp, usually driven by sales heads, will clamor for increased promotions, rebates and offers that collectively reduce the net revenue per sale to make the product's value proposition attractive to the consumer. The team advocating for strategic partnerships will make the case for alliances that increase the addressable market pie, but with some quid pro quo arrangement that both parties make to help each other's business. Google's (GOOG) alliances with Android-based smartphone manufacturers are generally in this category. This approach requires an 'open innovation' mindset with a culture to share rewards with partners, but going by Apple's 'do it my way' approach till date, this may be a huge cultural pill to swallow.

A strategic approach along the lines above may not have a favorable short-term impact on Apple's P&L but it could be quite beneficial in the longer-term, making Apple a stronger company in the future (if the approach delivers the expected long-term rewards). Unless there is a short-term 'game-changer' Apple already has up its sleeve that is expected to be unleashed shortly into the market, the above strategic approaches that any rational consumer products company would undertake at this stage will need substantial time to bear results in the market and in its P&L.

One near-term approach that Apple could take is opportunistic pricing of its iPhone 5 and iPhone 4S models, 'sandwiching' its competitors into a difficult chasm of comparison. But this approach may not work against entrenched competitors like Samsung (OTC:SSNLF) and HTC who can do the same with their top-selling and previous version models. It could make iPhone 4S a 'loss leader' at a very aggressive price point to gain share against the 'tier 2' brands. The real challenge comes when iPhone 5 starts to feel the pricing pressure in light of constant comparisons with Samsung SIII.

I realize this article focuses exclusively on the smartphone but this is where Apple earns the bulk of its profits and is clearly, a 'must win' product segment for Apple. However, interested readers can do similar comparisons with its other products (notably, iPad vs. Galaxy Note 2), and even there, competitors are catching up quite fast.

Source: Apple's Moment Of Truth And Way Forward