Although many high technology investors have heard of and know the tenants of Moore's Law, I am certain that few know its full ramifications in the end products and how companies using components that follow it can be left behind in the marketplace.
In my previous article, I highlighted how Apple's (NASDAQ:AAPL) iPhone 5C had essentially failed because it was a "tweener" product that was living in the shadow of the iPhone 5S in the carrier subsidized model and too expensive at $549 for the unsubsidized market. Furthermore, the company has remained rigid in its pricing as a signal to the market that it wants to be a premium supplier. This is at odds to how Moore's Law works along with what I would call its Democratization vector, which is different than its Performance vector.
If one reads the books on Robert Noyce by Leslie Berlin and Andy Grove by Richard Tedlow, one will note that there is a constant replay of creating new products or processes that enrich Fairchild and Intel (NASDAQ:INTC) at the early stages but quickly become diffused to other competitors leading to deep commoditization. Intel's invention of a high volume DRAM based on a new process gave it a multi-year advantage. Like Apple, its Revenue exploded from nothing to $400M in 10 years and then to $1.6B in 1984, the year prior to its exit from the DRAM market. During this 15 year period of increasing sales, Intel's market share dropped from 100% to around 2-3%. Note how a booming market can lift all boats and mask an underlying weakness that leads to eventual decline.
From the experience of DRAMs, Andy Grove, once they had captured IBM's (NYSE:IBM) PC, set out to not just single source their processor but also to implement a waterfall pricing strategy that allowed Intel to capture nearly 100% of the profits and 80% of the market volume while constantly pushing processors down in price every quarter. As a result Intel sold six to ten processors between the price of $60 and $1000 while they kept AMD (NYSE:AMD) in check typically below $80. Pricing could vary based on Fab loading decisions, but in general they were untouched through Grove's reign which ended in 1998.
It is important to note that Intel's expansive price model allowed the market to determine what quantity was bought in each of the different stair step price ranges and therefore allowed the Performance Vector to reign with the new $1000 processors and the Democratization Vector to thrive at the low end which constantly pushed PC prices lower, eventually to $999 and then to sub $500. All the while Intel stayed out of the money losing bottom 20% of the market.
Apple's rigid stance at the entry level is not based on the underlying economics of the components that have seen their costs drop dramatically in the past three years. And as such the result is that the Moore's Law Democratization Vector is driving volume to smartphone makers who are making the proper feature tradeoffs to hit key price points. Ryan Reith, program director with IDC's Worldwide Quarterly Phone Tracker, said recently that "Markets like China and India are quickly moving toward a point where sub-$150 smartphones are the majority of shipments, bringing a solid computing experience to the hands of many." In other words, the Democratization vector has made $150 the new $300. And look for the trend to continue... forever!
Therefore, the question that many should ask Tim Cook is why Apple is only playing the Performance Vector with its $649 iPhone 5 and neglecting the Democratization Vector that is driving the volume market to lower and lower price points. In other words, why is Cook not figuring out a way to move the entry level phone to the optimum price point that enables the company to capture 80-100% of the industry profits while not sacrificing on customer satisfaction and product quality?
The market is baring witness to the fact that $549 is an island without customers who are now hanging out somewhere around $300-$399 and which Moore's Law has already enabled from a component cost side. Thus Apple as a company is ceding territory to competitors that become more entrenched the longer the iPhone holds out at $549.
My guess on why Apple has not moved aggressively along the Democratization Vector is that once it reached the $150B revenue level there was a fear that price cuts would result in a cannibalization that an increase in volume could not make up for. It's the same scenario that IBM and Intel have faced over the years. The problem for Apple is that Moore's Law never lets the industry sleep. It is constantly pushing along the Democratization Vector and if Apple does not act, it will lose out to those who do follow it.