Apple (AAPL) has been a fantastic company to follow since it was created in 1976 by Mr. Jobs and Mr. Wozniak, providing students with multiple case studies and career motivation. Apple is the perfect example of what the American Enterprise System can create. Apple's product successes drove the stock from the 2009 bottom of around $90 to a high of $705 in 2012.
Pessimism around the stock and the company has risen dramatically with the fall of the stock price. At this point, it doesn't seem as though Apple can do anything to please any of their analysts. I read as many of the analysts' reports as possible and find the analysts to be financially brilliant. Their knowledge however, of product development, product marketing or manufacturing in the consumer electronics space, I find is quite deficient. Therefore, many of the conclusions they reach in regard to what products should be created, what their competitive deficiencies or advantages might be or what a future build plan portends to be naively inaccurate.
Estimating Apple earnings has also been problematic, and Apple has missed analyst estimates the last three quarters, resulting in a decline in price of some 35%.
So how can we be absolutely sure that Apple is still performing at world-class standards and not careening into oblivion as many analysts and writers would lead us to believe?
I decided to turn to the acknowledged expert on what makes a great company, Jim Collins. Mr. Collins has a research lab and consulting practice based in Boulder, Colorado. Four of his six books cover this subject: Good to Great; Built to Last; Great by Choice; and How the Mighty Fall.
One of the persistent criticisms of Apple is that it is no longer an innovator, its last product innovation being the iPad. Mr. Collin's research does not support the premise that 10X companies, as he refers to them, are any more innovative than their less successful comparison companies. The 10X companies, in some cases, were clearly less innovative than their comparisons. Other researchers support this same conclusion as well. This doesn't mean that innovation is unimportant but that the combination of creativity/innovation and discipline are important. Apple's creativity is clearly evident in their product design and their prolific patents. Their discipline to do things the Apple way often drives their critics to distraction.
Another concept that Mr. Collins introduces in Great by Choice is that world class companies fire bullets before cannon balls. The object is to turn small successes into larger successes. The definition of a bullet is: an empirical test aimed at learning what works. One that costs little or that is low in risk and a test that imposes little distraction for the company. What the market seems to want from Apple is the next big thing, an iTV or a huge acquisition like Netflix or a large cash payout. Bold moves like this (cannonballs) fired indiscriminately, is what dooms good companies to failure. We have seen Apple make multiple acquisitions of small companies (bullets). We have recently seen Apple fire a bullet in the form of Apple TV. I suspect the next bullet they may fire might be an SDK for Apple TV. I would suggest that when Apple has the empirical validation they need, they would then fire the cannonball the market is expecting.
Another symptom of decline can be the failure of a leader to develop a strong successor. Tim Cook has received his share of criticism from outsiders. Like other CEO's, Mr. Cook must prove himself to employees, board members and stockholders daily. We cannot, however, accuse Mr. Jobs of not carefully grooming and choosing his successor. In fact, if we refer back to Mr. Collins' book Good to Great, he has carefully researched the leaders of great companies and Mr. Cook nearly perfectly fits the personal and professional profile Mr. Collins has developed for great corporate leaders. Mr. Cook has great promise. Only time will tell if he develops into a great leader.
In an earlier book How the Mighty Fall, Mr. Collins researches formerly great but failed companies, why they failed and how some companies recovered and returned to greatness. Apple, like IBM has already recovered from past near failures. Mr. Collins' research identifies five stages of decline that are present in failing or failed companies.
The first crack in a company's armor is overconfidence created from past success. Demonstrable hubris manifests itself in different forms. It might be demonstrated by getting into a business that they know very little about. It might be rushing a product to market, pursuing growth that they cannot support, risky decisions that appear to have conflicting evidence or just plain neglect born of arrogance. Apple has clearly been successful since Mr. Jobs started his second tour of duty. Mr. Cook has said, "The most important thing to Apple is to make the best products in the world that enrich customers' lives." Outsiders are frustrated by the limited flow of information from Apple but at this point the term hubris (excessive pride) does not seem to apply to Apple.
The second stage of decline is the undisciplined pursuit of more. It is commonly understood that most companies fail or falter because they become complacent and failing to innovate, an allegation we often see in the media regarding Apple. Mr. Collins' work demonstrates that complacency is seldom the cause for decline but over reaching is more often the problem. Growing the company too fast, not being able to hire enough highly qualified people or acquiring companies that they are unable to absorb efficiently or in a timely manner are indications of over reaching. This is the area that probably least applies to Apple, demonstrated by their conservative use of a very large cash position and the constant calls in the media to spend that money in some spectacular way.
The third stage of decline is the denial of risk. Companies can characterize this state when they make big bets concurrent with mounting evidence that appears to be contradictory to their success. Mr. Collins identifies a common corporate behavior in this stage when leaders begin to blame others or external factors as they decline. Another manifestation of this problem is obsessive reorganization. So far, we haven't seen this type of behavior from Mr. Cook or his lieutenants.
We do have some warning flags that deserve careful scrutiny. Financially, the deterioration in gross margins is the most disconcerting. Their debt is not an issue but there might be signs of mediocrity. Declining customer engagement, inventory issues (most of these have been related to the inability to meet demand) and any potential pricing power issues.
The final two stages of decline identified by Mr. Collins are management grasping for salvation and finally capitulation, which results in a sale or cessation of business. These two final stages are clearly not in play.
We can conclude that by studying Mr. Collins' work we see little evidence that Apple has symptoms contained in stage one or stage two of corporate decline. The description provided of stage three provides us with areas to watch that might determine Apple's future direction. The bottom line, as is often the case, will Mr. Cook and his management team lead Apple to even greater success? They certainly have that opportunity!
Disclosure: I am long AAPL.